Trading (and predicting) earnings surprises

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1 Local residents crowd a swimming pool during a hot weather in Suining, Sichuan province, 27 July REUTERS/Stringer (CHINA). Trading (and predicting) earnings surprises Jessica Stauth Ph.D. Director, Quant Strategy Thomson Reuters / StarMine Research

2 Agenda Motivation Asset prices reflect market expectations, which can adjust rapidly when new, material information such as with a quarterly earnings reports are made public. Can earnings surprises be predicted? StarMine s SmartEstimate incorporates historical analyst accuracy and cluster analysis to deliver a better earnings preview Methodology for computing the SmartEstimate and for tracking analyst accuracy Historical accuracy of SmartEstimate and Predicted Surprise Preview of a new dataset of buyside and independent analyst estimates from Estimize 2

StarMine s SmartEstimate incorporates historical analyst accuracy and cluster analysis to deliver a better earnings preview Methodology for

3 Asset values reflect future expectations Consensus estimate aka the Street : Simple arithmetic mean of analyst estimates for a given fiscal period (e.g. FQ1) and a given financial measure (e.g. eps, dps, rev, etc.) (Primary sources: brokers; Aggregated sources: Thomson Reuters I/B/E/S, Zack s, Morningstar, etc) StarMine SmartEstimate : designed to create a more accurate earnings forecast than the consensus estimate by differentially weighting analyst estimates based on each analyst s historical track record and how long ago an estimate was issued. Estimize estimate: buy-side and independent analysts (and day traders in their bathrobes?) log their estimates via Estimize s free/open crowd-sourced website. 3

) (Primary sources: brokers; Aggregated sources: Thomson Reuters I/B/E/S, Zack s, Morningstar, etc) StarMine SmartEstimate : designed to create a more accurate earnings forecast

4 Whether a company misses or beats expectations can have substantial price impact, both immediately and over the course of the following days/weeks NFLX Street expected : - $0.12 Actual EPS: $0.13 Street expected : $0.18 Actual EPS: $0.31 4

course of the following days/weeks NFLX Street expected : -

5 Is it possible to predict when a stock will miss/meet/beat the Street s expectations? StarMine SmartEstimate represents an attempt to improve on the simple consensus mean and PREDICT earnings surprises. Formulation overview: Start with I/B/E/S detail level data (analyst by analyst coverage) Exclude data errors & stale estimates Statistical outliers Stale data (>120 days old) Additional proprietary cluster analysis techniques Compute a weighted average from the remaining fresh estimates based on Estimate age Analyst s historical track record for that particular stock 5

Formulation overview: Start with I/B/E/S detail level data (analyst by analyst coverage) Exclude data errors & stale estimates Statistical

6 Analyst accuracy star rating for each analyst by company and industry StarMine got its start researching which analysts to pay attention to. That research has been extended to stock selection models based on anomalies in analyst behavior. Reward analysts for being both different from the mean estimate and more accurate Measure accuracy throughout the period so that revising earlier and being more accurate is rewarded Consider the difficulty of the stock: some stocks are harder to predict than others Analyst Consensus Forecasting skill is persistent: This year s 5-star analysts are four times more likely to earn 5 stars next year than to drop to 1 star

Reward analysts for being both different from the mean estimate and more accurate Measure accuracy throughout the period so that revising earlier and being more

7 Historical comparison of accuracy: SmartEstimate vs. Simple consensus 7

8 Historical comparison of accuracy: SmartEstimate vs. Simple consensus (cont d) Significant Predicted Surprises (> 2% in magnitude) correctly call the direction of earnings surprises almost two-thirds of the time. 8

Surprises (> 2% in magnitude) correctly call the

9 What s better than a Predicted Surprise? A Predicted Surprise accompanied by corroborating revisions to the consensus. 9

10 Large Predicted Surprises followed by corroborating revisions have higher predictive power 10

11 New data service, Estimize provides another perspective on market expectations Estimize : buy-side and independent analysts (and day traders in their bathrobes?) log their estimates via Estimize s free/open crowd-sourced website. Coverage: For the period between January 1st and March 31st of 2013, Estimize had coverage on 900 US traded stocks. Contributor base: ~ 2,765 individual contributors 11

) log their estimates via Estimize s free/open crowd-sourced website.

12 NFLX revisited Estimize analyst-contributors have historically outperformed the consensus Street: $-0.12 Actual $ 0.13 Estimize $-0.05 Estimize D= +%58 (n=77 estimates) 12

13 Demo Trading a long-only earnings surprise strategy in Quantopian powered by Estimize data 13

14 Appendix 14

15 StarMine s Predicted Surprises are accurate across cap ranges, sectors and geographic regions. 15

16 StarMine s Predicted Surprises are accurate for multiple financial measures beyond EPS. 16

17 Data set for the updated SE whitepaper (2008): We utilized I/B/E/S data of analyst estimates and reported actuals at monthly frequency from January 31, 1995 to November 30, Because the availability of historical quarterly estimates is poor in most countries outside the U.S., we conducted our analysis utilizing only fiscal year estimates for the then-current fiscal year period (FY1). 17

Because the availability of historical quarterly estimates is poor in most countries outside the U.

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