Do-It-Yourself Analyst Predictions

by Glenn Curtis (Contact Author | Biography)

There's a misconception within the investment community that public companies give Wall
Street analysts more precise earnings guidance than they give the average investor. This is
simply not the case. Analysts generate their models by using the mosaic theory. They essentially
piece together bits of information and weigh the probabilities to come up with an earnings
number and get a feel for where the company is headed.
Individual investors can do this too if they know what to look for and what information to gather.
In this article we'll explore what kind of information you can look at to put the pieces of the
pule together for yourself. !The first step is knowing where to get the information you need. To
learn where to go" check out The Flow Of Company Information.#
argins
Individual investors need to get a handle on a company's gross and operating margins because"
frankly" they provide the best clue as to where earnings are headed. In order to do this investors
should first examine the company's latest $uarterly earnings filing !form %&'(# on the S)*
website. This will allow you to see where the margins have been over the last few $uarters and if
management has made any comments on where margins are headed. This information can be
found in the +anagement ,iscussion and Analysis !+,-A# section. In short" this will give the
individual investor a baseline to work with.
.ext" it's time to see what's going on in the current $uarter. Try to answer these $uestions/
0as management made any mid'$uarter comments on pricing1
0ave competitors hinted about pricing pressures1
Is the company heavily discounting its products through the use of coupons1
These bits of information will provide hints as to whether things are tracking according to
managements plan or if perhaps margins are on the decline. !2or more" see The Bottom Line On
Margins.#
It's hard to divine an exact number with 3ust this little bit of information4 however" one can look
back at historical $uarters and see the typical variance in margins over time as well as factor in
management's prior guidance if any. 5y doing this the investor will have a better feel for exactly
how low the margins might go.
!eep An "ye #n $e% Products
6ery often in the +,-A section or during a conference call" management will make comments
about up'and'coming products. The comments are fairly general" but they will usually include
expected sales and launch dates that can give you a starting point. Investors should take note
when comments like these come out because extrapolations can be made to determine the
potential impact on the bottom line in the current year.
Example - New Product Announcement
7ou comb through the latest +,-A section and find
this hidden gem from Widget*o.
!e plan to launch our new Tur"o!idget on Fe"ruary #
and to do $#%% million in annuali&ed sales'
2rom this we know that the company probably won't do
8%&& million during the current calendar year. 9ather"
it's planning on generating 8%&& million shares from
2ebruary to 2ebruary !its fiscal year#. The amount
generated in this calendar year will probably be around
8:%.; million. 0ere's how that works/
&'(( )illion * '+ , &-.// )illion in re0enue per
)onth
&-.// )illion 1 '' )onths (2eb-Dec) , &3'.4 )illion.
!Note/ This is an approximation because it takes time to
ramp up sales.#
Taking this one step further" if we know that the
company usually generates a %&< net margin on its
products" then we know that 8:.%; million will probably
fall right to the bottom line in this calendar year. And if
we know that" it's easy to divide that amount over
the number of outstanding shares and figure out the
earnings'per'share contribution the product could make.
To be clear" this is not an exact science" and because things change constantly" analysts must
constantly tinker with their models. 0owever" investors can and should be using this same
thought process to help them in their investment decision making.
5oo6 2or Possible Proble)s
0as management said that the company has some obsolete inventory on the books that the
company needs to write off1 =r are they planning on exiting a particular business1 If so" they
will usually provide estimates of any planned charges to earnings in a press release" conference
call or in the +,-A section.
5ut even if the company doesn't provide an estimate" sometimes the investor can determine how
much will be written off by other comments that management makes.
Example - (o It )ourself !rite*Off Calculation
>et's imagine that during a conference call a *2= said/
!e are going to write off our entire in+entory of
"ase"all glo+es'
2rom this" the investor can then look at the description
of inventory in the latest $uarterly filings and then
determine what percentage of the total inventory is
composed of baseball gloves. If it's ?< things might not
be too bad" but if it's ?&< ' watch out. In short" this will
give the investor a clue as to how big of a hit the
company may take in the upcoming $uarter. !To find out
more" see ,ead This Before )ou -ell.#
$e% Distribution Channels
Sometimes a company has great products and must simply build out new distribution channels to
succeed. If this is the case" try to determine if a product or service would be a good fit for a
ma3or store or channel. =ften" you can make a suggestion for bettering the product distribution
right at a conference call meeting. 7ou'd be surprised how candid management can be.
Another option is perusing analyst reports !available to clients of the brokerage# or checking out
the +,-A section. There is a lot of information out there once you start looking. !To learn what
information and input you're entitled to" see .nowing )our ,ights As A -hareholder.#
)ven if you get the answers you are looking for" it's important to remember that this is far from
an exact science. 2or example" even if a ma3or retailer agrees to carry a company's product it's
usually on a test'basis first. It will then expand distribution based upon demand. Also" in order to
get into a large distributor" the vendor must often reduce its selling price dramatically. 0owever"
information on potential new distribution channels can still help individual investors determine if
the company has a chance of beating the current consensus estimate on the Street. !To learn
more" see Can /arnings 0uidance Accurately Predict The Future1#
7hat8s 9he Co)petition Doing:
+any investors look at companies as if they existed in a vacuum. Instead" they should be
weighing what could happen if new competition has emerged or exited the business. If" for
example" Widget*o had been dominating the market" but suddenly WidgetTech is coming out
with a better product" it's possible that the earnings estimates for the Widget*o could be in
3eopardy.
0ere's how analysts would put an estimate on the impact to Widget*o's earnings/
2irst" analysts determine how big the market potential for a new widget product is
through extensive research" and then determine how long they think it will take to fully
tap that market.
Then" they make estimates to determine what percentage of the market each widget
maker can capture.
2inally" they back themselves into an approximation of the potential impact to earnings.
This is probably beyond the average investor's range of expertise and ability. 0owever"
individuals can still take note of new products in the market" and attempt to determine if they'll
hurt a particular company's sales or earnings or if the current consensus estimate for that
company might be too aggressive. !2or related reading" see Competiti+e Ad+antage Counts and
The Ad+antages Of In+esting In Aggressi+e Companies.#
2ind ;i)ilarities or Bench)ar6s
Whether analying the potential for a new product or a company's overall earnings potential" try
to find another company in a similar situation and then extrapolate accordingly.
Example - 2sing Benchmar3s
>et's say drug company @fier !.7S)/@2)# came out
with a product that reverses male pattern baldness and
the drug generated 8%&& million in sales during its first
year in the business. Then a small pharmaceutical
company with a smaller sales reach and fewer
distribution outlets comes out with a similar product
!whose efficacy is similar#4 it's pretty safe to say that the
small company won't be able to generate 8%&& million in
sales its first year. So" investors should be skeptical of
analysts or companies who say it could.
*onversely" if +erck !.7S)/+9A# and Bohnson -
Bohnson !.7S)/B.B#" two drug companies of similar
sie to @fier" were to develop and co'promote a similar
product !and they had twice the distribution network that
@fier had#" you may be able to estimate they could
indeed generate as much as twice the amount of sales in
the first year.
=f course" this example is an oversimplification. Some doctors will be reluctant to recommend
new drugs" and @fier might already be developing a stranglehold on the business" for example.
5ut for simplicity purposes this is how it's done. Again" the ob3ective is to get a frame of
reference and then to make as accurate of an estimate as possible.
Are Cost ;a0ings Possible:
.ext look at what the company is doing to save money and what it could do in the future. Is it
about to lay off %&& workers" or is it going to close a particular facility1 If so" keep in mind that
there could be some upfront severance or plant closure costs that could affect the current $uarter.
0owever" also keep in mind that this will also probably save the company a good deal of money
going forward.
If the company doesn't give a hint as to what type of employees it will be letting go !upper
management" middle'management" assembly'line workers" etc.#" you can make an assumption
that the average employee makes around 8C&"&&& a year and then piece together a basic cost
savings estimate. Similarly" if a company is about to get rid of a building" one can assume that it
won't have to pay taxes or do maintenance on the facility going forward.
9he Botto) 5ine
Analysts use the mosaic theory to piece together information about a company and then make
assumptions about that company's earnings going forward. The good news is that savvy investors
who are willing to do a little footwork on their own can do the same thing.
by Glenn Curtis !*ontact Author D 5iography#
Elenn *urtis started his career as an e$uity analyst at *antone 9esearch" a .ew Bersey'based
regional brokerage firm. 0e has since worked as an e$uity analyst and a financial writer at a
number of printFweb publications and brokerage firms including ,egistered ,epresentati+e
Maga&ine" Ad+anced Trading Maga&ine" Worldlyinvestor.com" 9eal+oney.com" TheStreet.com
and @rudential Securities. *urtis has also held Series G";"?H and GI securities licenses.
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