Recognizing a Real Earnings Surprise

 |  Includes: CSCO, CTXS
by: John Scherr

Why is it that some stocks skyrocket on a positive earnings surprise while others drop like a wet sack? In this article we take on this little understood issue and look to help you take advantage of and profit from earnings surprises.

Not that long ago earnings data was limited to a few numbers - the one the company expected and then the actual earnings released. But now, with every quarter, investor's are bombarded with a mass amount of quarterly earnings information - different numbers, different sources, and different expectations. The majority of this information is useless to the average investor. Figuring out the difference between the 'meaningful' and the 'meaningless' can be difficult but is an important aspect to finding a real earnings surprise.

Earnings 'estimates' rely on analysts to provide an earnings consensus, however, collects earnings 'expectations' from investors. (Suffice it to say that analysts some how maintain power and gain the most media coverage for consistently being wrong and reactionary with their so-called analysis.)

We're sure you've heard the statement that "at the end of the day, all stock price movements can be traced back to earnings." We're not sure who said it, but we think that's only partially correct. We'd add that while all stock price movements can be traced back to earnings, at the end of the quarter, only expectations move markets.

Studies have found that the best earnings expectations data comes from the masses (varied investors), not analysts. Earnings expectations (whisper numbers) do not come from analysts nor do they come from some unknown or inside source. For over twelve years has collected quarterly earnings information from a vast database of investors registered with our website. These investors are a combination of individual investors, floor traders, investment advisors, and market strategists. The data is sourced, compiled, and provided for free on the website. The data is the only earnings information that has been proven (via independent academic sources) to be an accurate, reliable, and useful trading tool. More important? It's been proven an indicator of a real earnings surprise.

After studying the earnings data (whisper numbers) we've collected, we've been able to understand some basic 'surprise' patterns or predictive principles that have developed and take place around earnings releases.

One of the primary predictive principles is as follows:
Stock prices have a greater tendency to increase (or decrease) based upon whether or not the actual earnings of a company beat (or miss) the whisper number expectations provided by

For example, last quarter Cisco (NASDAQ:CSCO) reported earnings of 43 cents (Aug. 11th). This was one cent ahead of the analysts estimate and should have been seen as a positive surprise. But the stock dropped close to 16% in fourteen trading days. One of the reasons for the drop? Cisco missed the whisper number of 44 cents by a penny.

Another example is when a company reports earnings that miss the analysts estimate but see a positive surprise. (This is a less common situation as analysts are known to be conservative with estimates.) Citric Systems (NASDAQ:CTXS) reported earnings of 41 cents on July 28th. This was four cents less than the analysts, but one cent ahead of the whisper number. While the mainstream media was reporting an earnings miss, investors following expectations were expecting a positive price move. Citrix is up 44% since that report.

While these are just two examples, the pattern has repeated itself over the past twelve years of data collection. In fact, the independent academic financial study (of data) titled 'Do Bulls and Bears Listen to Whispers' concluded the following:

'A post-earnings announcement drift associated with the market reaction to analyst forecasts errors remains a puzzle. This study suggests that whispers help to explain part of the puzzle. The study examines the market reaction to whispers and analysts in bull and bear markets, and finds that investors listen to whispers in the bull market and whispers help explain the post-announcement drift.'

A company's 'reaction' to the whisper number expectation is the key - on average companies that exceed the whisper are 'rewarded', while companies that miss are 'punished' following an earnings report. has analyzed our data, and looked for a specific set of companies - companies that have 'reacted' to the whisper as we would have expected - companies that saw strength when they beat the whisper, and weakness when they missed. We call this special set of companies 'whisper reactors'. These are the companies from which investors can expect a consistent earnings surprise. (But we'll address that in our next article.)

Real earnings surprises won't be found in the mainstream media, and they won't be found when looking at the analysts estimates. To profit from a real earnings surprise traders need to follow their own expectations.
Disclosure: No positions