What is an Earnings Surprise?
How Does an Earnings Surprise Work?
Let's assume that analysts expect Company XYZ to report $0.05 in earnings per share for the first quarter. If the company reports $0.11 per share for the quarter, then we can say that there was a positive earnings surprise for Company XYZ.
A positive earnings surprise generally means that a company did better than expected over the last quarter. Many times, a positive earning surprise is followed by a jump in the company's share price as soon as the market opens following the announcement. However, this is not always the case as investors look at many other items in quarterly results, such as revenues, margins, and future earnings guidance. If one of these metrics comes in below expectations, if could cause a drop in the firm's stock. Likewise, an earnings short-fall can cause a sharp drop in a company's stock. In either case, earnings surprises introduce volatility to the market.
Why Does an Earnings Surprise Matter?
Earnings surprises are one reason earnings estimates and earnings season are so interesting to investors. An earnings surprise could make a stock move up or down by 10% or more in a single day. However, the company isn't always the source of an earnings surprise. Sometimes the analyst estimates are flawed. This is not unusual because forecasting is a difficult endeavor, and analysts are often tempted to fall in line with what others are forecasting.
In less ethical situations, analysts may be pressured by their employers to send a certain message about a stock, or quite often the company provides information that will lead analysts to publish earnings estimates that the company will easily beat (known as sandbagging).