Definition, Functioning, and Illustration of Consensus Estimate

What Is a Consensus Estimate?

A consensus estimate is a predictive forecast of a public company’s anticipated earnings based on the combined assessments of all equity analysts covering the stock.

In general, analysts forecast a company’s earnings per share (EPS) and revenue figures for the quarter, fiscal year (FY), and future FYs. The scale of the company and the number of analysts analyzing it influence the breadth of the consensus estimate pool.

Key Takeaways:

• Consensus estimates represent an average of forecasts for company revenues and earnings by analysts monitoring a stock.
• These estimates are not a precise science and are contingent on various factors, from access to company records to past financial reports and market projections for the company’s products.
• If a company falls short of or surpasses consensus estimates, it can lead to a sharp decline or surge in the stock price, respectively.

Understanding Consensus Estimates

When you encounter terms like “missed estimates” or “exceeded estimates” regarding a company, it often refers to consensus estimates. These forecasts are accessible in stock listings or platforms such as the Wall Street Journal’s website, Bloomberg, Visible Alpha, Morningstar.com, and Google Finance.

Analysts aim to forecast what companies may achieve in the future, based on projections, models, subjective evaluations, market sentiment, and empirical studies. Consensus estimates, originating from numerous individual analyst evaluations, are often more akin to an art than a precise science. Analysts base their research on financial statements as well as their subjective judgments and interpretations.

Analysts often integrate information from various sources into a discounted cash flow model (DCF). The DCF method employs future free cash flow (FCF) projections and discounts them using a standard annual rate to derive a present value estimation.

If the derived present value surpasses the current stock market price, an analyst might predict a value “above” consensus. Conversely, if the present value of future cash flows is lower than the stock price at the time of calculation, the analyst may infer the stock is priced “below” consensus.

Consensus Estimates and Market (In)Efficiencies

Some specialists argue that the market’s efficiency is not as pronounced as commonly believed, asserting that this efficiency hinges on possibly inaccurate estimates about myriad future occurrences. This may clarify why a company’s stock swiftly adjusts to fresh data provided by quarterly earnings and revenue figures when they deviate from the consensus estimate.

A survey conducted by consulting company McKinsey in 2013 revealed that missing consensus estimates typically has no significant impact on a company’s stock price. The study noted that falling short of consensus earnings estimates seldom causes a dire consequence in the short term.

Their report demonstrated that missing the consensus by 1% results in merely a two-tenths of a percent decline in share price in the five-day period following the announcement. However, the study cautioned against overinterpreting these findings, suggesting that consensus estimates may imply prevalent investor apprehensions about a particular company or sector.

Example

For instance, let’s consider Molson Coors Brewing Company (TAP). In 2010, the beverage producer surpassed consensus estimates by 2%. However, its shares dropped by 7% because investors attributed the earnings surprise to a one-time tax benefit rather than an enhancement in the company’s fundamental strategy and long-term profitability.