What is a Consensus Estimate?
A consensus estimate is a shared prediction of a company's quarterly or annual earnings per share.
How Does a Consensus Estimate Work?
Securities analysts are tasked with the job of making earnings estimates for the companies they cover. This involves analyzing and accurately forecasting the performance of these companies. They often do this by reading all of the disclosure about a company as well as talking with management, visiting the company, studying the product and monitoring the industry. For each company, they create detailed mathematical models that reflect the facts and the analyst's judgment about what will happen next. The analyst disseminates these earnings estimates to his or her clients, who may use that information to buy or sell securities. Many companies and websites also publish the earnings estimates for any given security.
Many analysts might follow the same security, and this is why many people often consider the average or median of these estimates as more important that any one analyst's estimate. So if the consensus estimate is that Company XYZ will report $0.50 of earnings per share next quarter but the company actually reports $0.45, Company XYZ has 'missed estimates.' If Company XYZ actually reports more than the consensus, Company XYZ has 'beaten estimates' or 'beat the street.'
In both cases, if the company significantly beats or misses consensus, this is often called an earnings surprise. Missing or beating numbers can be a telling sign for the company, but it can also mean that the analyst simply got it wrong.
Why Does a Consensus Estimate Matter?
Many people make investment decisions based on earnings, and so earnings estimates are important not only because they provide some indication of what financial experts think might happen next for a company, but they set the tone for the security's trading in the short term (note that long-term investors are less sensitive to this ebb and flow). A stock price often goes down if the company misses, and often goes up if the company beats the estimates. Thus, many investors know that the degree of divergence from consensus matters. This can be frustrating for companies that produce strong growth and good products but still suffer a decrease in stock price for failing to meet Wall Street's expectations.