Who are the people who set earnings expectations?

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Allen Tang asks:

You often hear that a company beat or missed "expected" earnings. My question is who are the people or entities that make these expectations, why do their opinions have so much power to move stock prices based on their "expectations," and where does the public get access to this information?

News about a company's earnings for the quarter will always mention whether it beat analysts' predictions.

Sell-side analysts at brokerages and investment banks who follow these companies are the ones setting these expectations, said Eric So, a professor of global economics and behavior science at MIT. That can include the likes of Morgan Stanley and Goldman Sachs.

"Data providers like FactSet, Bloomberg, and LSEG average those forecasts into a consensus estimate. That consensus is the benchmark people mean when they say a company beat or missed," So explained.

Management at the company itself will also set their own expectations, said Patrick Badolato, a professor of instruction in accounting at the University of Texas at Austin. When they do, they'll often give a range of what you might expect in the coming quarter instead of a specific figure, Badolato said.

"Analysts can change or update their expectations based on what management does," Badolato said. "Analysts can also change with respect to what other analysts do."

Analysts will set these targets based on a host of factors depending on the type of company and industry, including historical performance, consumer trends and the foot traffic at a company's stores.

You can find consensus estimates for free on Yahoo Finance and Nasdaq, while the company's own guidance is available to the public in earnings releases and calls, So said.

Companies are going to try to manage expectations so they can avoid underperforming relative to the targets that they release publicly.

"Analyst forecasts tend to start out optimistic and then get walked down as the announcement approaches, frequently after guidance or conversations with the company, so the bar ends up just low enough to clear. As a result, far more companies narrowly beat consensus than narrowly miss it," So said. "Analysts have reasons to go along, since playing along with managers’ preferences to create beatable targets tends to buy them access to management, which is valuable to their clients and their careers."

Even though the companies themselves help manage expectations, sometimes they can still get things wrong.

That's because when you make projections, there might still be weeks worth of business to be conducted, Badolato said. Macroeconomic events can also alter metrics in your earnings report, while contracts can be pushed off, and input and labor costs can change, Badolato added.

"We're always dealing with change and uncertainty in the world. So I would say we should expect them to be imperfect," Badolato said.

You can't get away with lowering your targets too much just so you can say you beat expectations, because then people will catch on, said Matthew Spiegel, a finance professor at Yale University.

"The analysts will go, 'Well, you know, gee, they just said this, so it must be 10% higher,'" Spiegel said.

Beating expectations can change the stock price for the simple reason that it's now more valuable than what experts predicted.

"If I thought the firm was going to earn $100 for me this quarter, and it actually earned $110, I'd be pretty happy. And if someone wanted to buy the stock from me, I'd probably charge them a little more, right? The firm is doing better than I thought it was, so it's worth more than I thought," Spiegel said.

Conversely, if the firm does poorly relative to what you thought, you'd have to offer the stock at a lower price if you want to get rid of it, Spiegel said.

"The person buying it is gonna go, "Well, you might have thought it was gonna earn 100 bucks, but they're only earning 90, so we're not gonna give you as much," Spiegel said.

Failing to meet expectations can also signal that there are other aspects about the company — like its long-term revenue trajectory — that the market didn't know about, Badolato said.

Basically, the market is admitting that it had incomplete information, Badolato said.

A small discrepancy between a company's earnings and expectations usually won't shift the company's stock price that much though, Spiegel said.

"When you see a small discrepancy in the earnings announcement and a huge change in the stock price, there's something else going on at the same time," Spiegel said.

A company may have announced that another firm plans to buy them, or maybe there were issues at one of their production plants, Spiegel said.