What is Earnings Estimate?
Earnings Estimate is the projection of earning of a company by analysts for a given period (Quarterly, semi-annually or annually) and is considered to be the most important factor that determines the future share price of the company. Future projects, cash flows, market conditions and several other factors are considered in calculating this estimate.
How to Calculate Earnings Per Share Estimation?
The market usually doesn’t want to see the whole earning of a company to do the share price estimation. The most useful data is EPSEPSEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is.read more estimation.
Let’s take an example of Company ABC has 5 product lines. Revenue from each product line from the last quarter are given below:
- Product LineProduct LineProduct Line refers to the collection of related products that are marketed under a single brand, which may be the flagship brand for the concerned company. Typically, companies extend their product offerings by adding new variants to the existing products with the expectation that the existing consumers will buy products from the brands that they are already purchasing.read more A: $5 Million (Seasonal product, the season is from Jan to June)
- Product Line B: $3 Million (Seasonal, Season will start from July and will end in December)
- Product Line C: $4 Million (Luxury Product)
- Product Line D: $8 Million (Fast Moving Consumer Goods – FMCG)
- Product Line E: $2 Million (Car production)
What are the factors that an analyst will consider and estimate the EPS for the next quarter that is from July to September? The total Share Outstanding in the Market is 10 Million.
Solution
There are several factors that an analyst should consider to calculate Earnings per Share for the next quarter. The analyst will have to study each product line very carefully.
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For eg:
Source: Earnings Estimate (wallstreetmojo.com)
Product Line A
This is a seasonal product, and we see that its season just ended. So in the last quarter that is April – June, it earned the company a revenue of $5 Million. So it is quite expected that the revenue will not be the same from this product line this quarter as it is seasonal and its season just ended. So the analyst will have to see past 5 to 10 years record and see what was the drop in the sales for this particular product line after June. Say the drop was 45% on average. So he will have to take a call as to whether he will consider 45% or lower or higher for this year. Say this year, he thinks that the drop will even be more. So the analyst considered a drop of 55%, i.e., -55%.
$5 Million * 55% = $2.75 Million
Expected revenue from Product Line A for the next quarter (July to September)
- = $5 Million – $2.75 Million
- = $2.25 Million
Product Line B
This is also a seasonal product whose season is just about to start. So the Analyst will again look into the past year’s data and see the rise in sales from July. Say the average rise in sales from July for the past 10 years is 40%. So now, the analyst will take a call as to what he will consider for this year. Say Football World Cup is scheduled to happen this quarter, and this product is related to sports. So the increase in revenue estimation should be more than 40%. Say the analyst considered the rise in revenue to be 50%. i.e. +50%.
$3 Million * 50% = $1.5 Million
Expected revenue from Product Line B for the next quarter (July to September)
- = $3 Million + $1.5 Million
- = $4.5 Million
Product Line C
Luxury product sales depend on the purchasing capacity of the country. To estimate the sale of a luxury product for the next quarter, the analyst will have to estimate the GDP growth rate for the quarter, the per capita incomePer Capita IncomeThe per capita income formula depicts the average income of a region computed by dividing the total income of that area by the total population of the region. It is used to figure out the average income of a city, provision, state, country, etc.read more for the quarter, any financial distressFinancial DistressFinancial Distress is a situation in which an organization or any individual is not capable enough to honor its financial obligations as a result of insufficient revenue. It is usually the result of high fixed costs, obsolete technology, high debt, improper planning and budgeting, and poor management, and it can eventually lead to insolvency or bankruptcy.read more for the quarter. Say after considering all the factors, analysts decided that the sale will drop by 10% for the next quarter, i.e. (- 10%).
$4 Million * 10% = $4 Lakh
Expected revenue from Product Line C for the next quarter (July to September)
- = $4 Million – $4 Lakh
- = $3.6 Million
Product Line D
Fast Moving Consumer Goods (FMCG) are sold mostly throughout the year. So for this, the analyst can calculate the revenue by seeing the past 10 years of data and see if any outliers are there or not in the data. Say in a particular year, there was a drop in sales due to flood; then, the analyst will have to remove this outlier before doing the calculation. Say the analyst finds out that the sale of this product remains constant for the next quarter as compared to the previous quarter.
Expected revenue from Product Line D for the next quarter (July to September)
- = $8 Million
Product Line E
Car sales depend on many factors. Price of fuel, economic condition, pollution control laws, availability of steel, and many others. So the analyst will have to predict the movement of all the factors and then estimate the sale % of the car for the next quarter. Say analyst finds out that Car sales will increase by 20% for the next quarter (i.e., + 20%).
$2 Million * 10% = $4 Lakh
Expected revenue from Product Line E for the next quarter (July to September)
- = $2 Million +$4 Lakh
- = $2.4 Million
So the Total estimated revenue of the company ABC for the next quarter can be calculated as follows-
Revenue from Product A + Revenue from Product B + Revenue from Product C + Revenue from Product D + Revenue from Product E
- = $2.25 Million + $4.5 Million + $3.6 Million + $8 Million + $2.4 Million
- = $20.75 Million
Earnings Per Share = Total Earnings / Total Shares Outstanding
- = $20750000 / $10 Million
- = $2075000
So $2075000 is the earning per share estimate for the next quarter.
Refer to the excel sheet given above for detailed calculation.
Earnings Surprise and How does it Affect Share Price?
Earning surprise is when the company earning is below or above the estimation that was done.
A positive surprise is always good for the company. Positive surprise means when the actual earning is more than the estimated earnings.
A share price that we see in the market is based on several factors, one among all the factors are earnings. The present value of all the future earningsEarningsEarnings are usually defined as the net income of the company obtained after reducing the cost of sales, operating expenses, interest, and taxes from all the sales revenue for a specific time period. In the case of an individual, it comprises wages or salaries or other payments.read more of the company is reflecting on the share price. So when there is a positive earnings surprise, that is, the earning is more than estimation, then the share price that you are seeing in the market was actually calculated with the help of estimated earnings. Now, as the actual earning has beaten the estimate, so it is new information that must be included in the calculation, so the share price starts to rise.
Conclusion
Earnings estimate is a very important factor in the market. It helps in determining the share price. It is always good for a company to beat the earnings estimate as it helps to build a reputation for the company in the long run.
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