Like everyone who practices a skilled craft, value investors have tools to help them invest successfully. Not every tool is used all the time, and no single tool is adequate for completing an entire project. So, it’s important for value investors to have a fully kitted toolbox, and to practice using the key tools, to help make the best investment decisions possible. This is particularly true in the currently confusing investment environment. One such key tool is estimate revisions.
What are estimate revisions, or “EstRevs” for short? As investors know, most companies above $500 million in market cap are followed by at least a few Wall Street analysts. Each analyst develops their estimates for upcoming quarterly and annual earnings for their companies, which are then averaged by data aggregation services like Cap-IQ, FactSet, Sentieo, and Thomson Reuters to create consensus estimates. These estimates are essentially Wall Street’s “best guess” for what each company will report and form the base for estimate revisions.
As each quarter progresses, and following quarterly earnings reports, the analysts adjust their estimates. These changes are quickly reflected in the consensus estimates. These revisions to the consensus estimate are the estimate revisions. They provide investors with the best guess of where a company’s earnings are headed.
Estimate Revisions & INTC
For example, the consensus estimate for full-year 2022 earnings per share for Intel Corporation (INTC) is $1.96. Three months ago, this estimate was $2.29. Since the estimate has declined 14% over the past 90 days, the 90-day EstRev is -14%. So, the general direction for Intel’s earnings is down.
How can this be useful to value investors? To help them avoid value traps. Value investors tend to look for stocks with low valuation multiples. The hidden assumption when using valuation multiples is that the earnings base is steady. So, if Intel was valued at 15.7x estimated 2022 earnings in August (about 90 days ago), the assumption was that the $2.29 earnings estimate was solid. But, as the company’s fundamentals continued to weaken, this otherwise solid earnings base melted by 14% to $1.96. Reflecting this, the shares have fallen 22% in the past 90 days.
Estimate revisions can also help investors avoid deeper losses over longer time periods. A year ago, analysts estimated that Intel would earn $3.76/share in 2022. With the stock then trading at 51, the valuation was a cheap-looking 13.6x. However, the estimate revisions at that time were headed down. Then, that earnings estimate went on to get cut in half, to $1.96. The stock followed the falling estimates and now trades around 28, almost half its year-ago price. And, the stock is actually more expensive, at 14.3x, than it was a year ago. Intel shares illustrate the definition of a value trap.
To help avoid value traps, value investors can look for companies with positive estimate revisions. These companies are more likely to have rising earnings, rather than declining earnings, thus providing a more solid base for the valuation. While no indicator is flawless, and positive estimate revisions can quickly turn negative following a disappointing earnings report, they can be a powerful tool to help investors understand the trends and story behind a company’s prospects.
Like most tools, the EstRev concept can be developed further. EstRevs can be calculated for almost any time period, with the most common being 30, 90, 180 and 360 days. And, with the proliferation of estimate metrics, EstRevs can be applied not only to changes in consensus earnings but also for revenues, EBITDA and others. In the hands of an attentive craftsman, this tool becomes more powerful.
Like all tools, EstRevs are not an end, but a means, to finding attractive value stocks. Both dedicated and developing value investors will want to add these tools to their toolbox.
At Cabot Undervalued Stocks Advisor and the Cabot Turnaround Letter, we help investors navigate the equity markets using a common-sense value-oriented approach that emphasizes out-of-favor stocks of companies with real value. Let us help you sort through the market to find them.