We all know that making an investment is not a joke. Taking it lightly is also a big ‘NO’. An investor does not make a drastic decision when it comes to his investments. The ultimate goal is to have it returned plus the interest. Most of the active investors make use of the estimates on earnings consensus as one of the significant factors in their final decision. But how much significance does this thing possess for them?
If you tracked down in the history, earning estimate and over reliance to it is not that good. Many studies prove that the predictive power of this estimates for the equity returns in the future is quite poor. In addition to that, active investors are likely to develop bad habits with relying to this estimate on earnings consensus such as:
Using these earnings estimates can create a mind-set with the investors that there is an utmost importance in what will happen in the coming quarter or with the year earnings-wise. But think about it, does missing quarterly number matters a business’ health over a long term?
A great example for this would be in expansion construction of a business. Earning your expenses back will be impossible to gain in the next quarter which could lead the business missing an earnings. This may not be good for the stock, but for the business it could be.
Most investors will simply tweak the estimates on earnings consensus then reflect it to their view of a company. Others just plug the consensus in the process of their decision making without bothering to study it first. This negligence is fine as long as your company is generating returns consistently and exceeding your benchmark. But if not, you are in for a big trouble.
They see a potential investment regarding the capability it has to earn and beat or meet the estimates on earnings consensus. Most of them checks the valuation model to see if it would be a good investment. With this kind of process, the independent judgement is totally gone.
Many investors presume that the earnings estimates play a crucial role in the process of investment. For them, they may contain information that are actionable. Many investors spend good money in order to get their research at a much higher cost than they should.
There is nothing wrong with using estimates on earnings consensus. But still are they reliable enough to make a decision for your investment without in-depth analysis from an independent source?
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