Analysts are almost always wrong. In an average quarter, for example, about two thirds of the companies reporting earnings will deliver results that exceed analysts’ consensus estimates. The consensus estimate is an average of all published estimates.
Of the remaining companies, usually more than half miss the consensus estimate. That means, in a typical quarter, the consensus earnings forecast will be right for just 10% of the companies. Analysts are wrong, in other words, about 90% of the time.
Despite that fact, analyst estimates are important to consider. Ignoring them because they are likely to be wrong is a mistake that some individual investors will make. But, many professional investors understand how to profitably analyze analyst forecasts.
Earnings Forecasts: General Trends Are More Important than Specifics
When it comes to earnings forecasts, it is important to expect good stocks to beat expectations. This is because that is usually what happens. When a good stock fails to meet expectations after several quarters of beating expectations, the stock often sells off sharply.
The reason for the sell off is not just because the company failed to beat expectations. Traders sell in response to the miss because they are worried management failed to communicate their expectations for earnings to analysts.
Communications with analysts is an important part of the modeling process. Analysts tend to create earnings models and then talk to management, along with customers and suppliers. Based on what they hear in these conversations, they may increase or decrease the earnings forecast by the model.
When a company misses expectations, it is possible that management failed to see something that had a large impact on the business. It might be that management failed to anticipate a downturn in sales or failed to manage expenses. Traders worry that this could be a significant problem for management since they were unable to spot the issue before it affected earnings.
On the other hand, when business is good, management will be relaying optimistic assessments to analysts. The analysts should then be increasing their estimates. It is the trend in estimate revisions that offer important information to traders.
Price Targets Are Based on Models
Analysts, of course, do more than generate earnings estimates. They also develop price targets for stocks and the earnings estimates are a factor in developing these targets. The models are usually based on a discounted cash flow model. The basic formula for this model is shown below.
The formula tells us the fair value (FV) of a stock is equal to the sum of all of its cash flows (DCF) multiplied by an appropriate discount rate. The discount rate recognizes that a dollar in the future will have less buying power than one today and deserves a lower value in the formula.
Earnings are a part of the cash flow estimates. When earnings estimates change, the target prices change. There are other models that can be used to find price targets but many Wall Street firms rely on the DCF model for the bulk of their work.
This means the price targets are based on models and are important to consider. If a company meets its earnings estimates, the stock is eventually likely to reach its price target. That means we should be able to find winning investments by buying stocks trading well below their price targets.
Stocks Analysts Love
We created a screen at FinViz.com using the free screening capability available at that site. The general screen is shown below, and the key criteria is that the target price is at least 50% above the current price. For example, this means a stock with a $20 target is trading at $10 or less and has significant potential.
We found six stocks trading at less than $10 a share that could double in value according to analysts and offer a dividend yield so that investors are paid at least something while waiting for the stock price to move.
Aegean Marine Petroleum Network Inc. (NYSE: ANW) operates as a marine fuel logistics company that markets and supplies refined marine fuel and lubricants to vessels in port, at sea, and on rivers worldwide. The company offers fueling services to ocean-going and a range of coastal vessels, including oil tankers, container ships, drybulk carriers, cruise ships, reefers, LNG/LPG carriers, car carriers, and ferries, as well as to marine fuel traders, brokers, and other end-users of marine fuel and lubricants. In addition, the company markets and distributes marine lubricants under the Alfa Marine Lubricants brand; and provides a range of shipping services, such as technical support and maintenance, insurance arrangement and handling, financial administration, and accounting services.
Analysts have a price target of $10 on ANW, which currently yields about 1.7%.
Bristow Group Inc. (NYSE: BRS) provides industrial aviation services to the offshore energy industry in Africa, the Americas, the Asia Pacific, and Europe Caspian. Its helicopters are used to transport personnel between onshore bases and offshore production platforms, drilling rigs, and other installations, as well as to transport time-sensitive equipment to these offshore locations. The company also offers helicopter flight training services to commercial pilots and flight instructors, as well as military training services through its Bristow Academy. The company also provides aircraft repair and maintenance services; and search and rescue services to oil and gas companies.
Analysts have a price target of $11.60 on BRS, which currently yields about 3.8%.
Celadon Group, Inc. (NYSE: CGI) operates as a transportation company, providing services between the United States, Canada, and Mexico. The company transports various types of freight, including tobacco, consumer goods, automotive parts, various home products and fixtures, lawn tractors and assorted equipment, light bulbs, and various parts for engines. CGI operates through three segments: Asset-Based, Asset-Light, and Equipment Leasing and Services. The Asset-Based segment offers dry van, refrigerated, and flatbed services; cross-border services between the United States and each of Mexico and Canada; intra-Mexico and intra-Canada services; contract services; regional and specialized short haul services; and rail intermodal services. The Asset-Light segment provides freight brokerage, warehousing, less-than truckload consolidation, and supply chain logistics services. The Equipment Leasing and Services segment offers tractor and trailer sales and leasing services, as well as insurance, maintenance, and other ancillary services primarily to the independent contractors and other trucking fleets.
Analysts have a price target of $11 on CGI, which currently yields about 1.7%.
Nabors Industries Ltd. (NYSE: NBR) owns and operates one of the world’s largest land-based drilling rig fleets and provides offshore platform workover and drilling rigs in the United States and international markets. The company also provides drilling technology, directional drilling operations and drilling instrumentation and software. Through its subsidiaries, the company manufactures and sells top drives, catwalks, wrenches and other drilling related equipment which are installed on both onshore and offshore drilling rigs.
Analysts have a price target of $13.28 on NBR, which currently yields about 3.2%.
National CineMedia, Inc. (Nasdaq: NCMI) operates an in-theatre digital media network in North America. The company produces and distributes various versions of FirstLook, a cinema advertising and entertainment pre-show on movie screens; sells advertising on its lobby entertainment network; and various forms of advertising and promotions in theatre lobbies. The company also sells online and mobile advertising through its Cinema Accelerator digital product and mobile app, including Movie Night Out. Its services are offered to third-party theatre circuits under long-term network affiliate agreements.
Analysts have a price target of $11.83 on NMCI, which currently yields about 13%.
Teekay Offshore Partners L.P. (NYSE: TOO) provides marine transportation, oil production, storage, long-distance towing, offshore installation and maintenance, and safety services to energy and oil service companies. The company operates through six segments: Floating Production, Storage and Offloading (FPSO); Shuttle Tanker; Floating Storage and Off-Take (FSO); Units for Maintenance and Safety (UMS); Towage; and Conventional Tanker. As of December, 2016, its fleet consisted of 31 shuttle tankers, 6 FPSO units, 7 FSO units, 7 long-distance towing and offshore installation vessels, 1 UMS, and 2 chartered-in conventional oil tankers.
Analysts have a price target of $.20 on CGI, which currently yields about 1.7%.
Any of these stocks could be a winner or investors could use this list of stocks to build a diversified income portfolio that emphasizes value.