In this Answers, Answers segment of this episode of Motley Fool Answers, Alison Southwick, Robert Brokamp and guest Morgan Housel (a former Fool now at the private equity VC firm The Collaborative Fund) consider the earnings expectations game: No company wants to merely meet expectations, and most investors want quarterly results that beat expectations. But if you expect to exceed expectations, what are your expectations, really? And how should those relative numbers guide Foolish investors' actions?
A full transcript follows the video.
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This video was recorded on Aug. 22, 2017.
Alison Southwick: Let's get to the question for today, shall we? It comes from Edward in Australia. He writes, "This earnings season we've seen a fair bit of volatility, which is to be expected. However, I was surprised by the number of companies that released great or expected results and immediately dropped in value. Investors not being happy even with awesome results suggests to me that a company might be significantly overvalued and when we see it with heaps of large companies, does this mean the whole market is too overvalued?"
Morgan, when you were at the Fool you wrote many a column about quarterly earnings reports. How do you feel about Edward's question?
Morgan Housel: I always think there's an irony or almost an oxymoron that most investors expect earnings to beat expectations. And if you're expecting something to beat expectations ...
Southwick: You're like, "Wait a second."
Housel: It's like this weird game. The expected numbers of a company "beating their numbers" is a game that's not really rooted in like, "Oh, well you beat your numbers so this should be good for the stock." Those expectations don't really mean anything. It's effectively a made-up number that companies and analysts picked out of thin air. "We're going to earn $1.32 per share during this quarter."
Southwick: Why not $1.31?
Housel: Right. It's just the numbers, themselves, are kind of meaningless. But more important, your markets are forward-looking, so a company can beat its earnings expectations for the previous quarter. But if it gives any guidance on the future that sales are going to slow down, or blah, blah, blah, or maybe the CEO just had a tone in his voice on the conference call that made investors a little anxious; then markets can react in that way.