The Earnings Expectations Life Cycle

Earnings surprise, earnings torpedo and earnings estimate revision are some of the expectational strategies that have become part of the portfolio manager's tool kit during the last decade. Although there has been much written on individual investment strategies relating to earnings expectations and stock performance, there appears to have been little written on how these various expectational topics fit together. This paper attempts to combine expectational equity factors within one graphic framework. The result may be helpful for stock selection, as well as lending insight into manager style, performance and transaction costs. The Earnings Expectations Life Cycle The Earnings Expectations Life Cycle illustrated in Figure A depicts how expectations for a stock change through time.' Most stocks probably travel such a path, although they don't necessarily stop at each point on the cycle. Each stock hypothetically travels at its own speed, and some might bounce repeatedly between two or three points before continuing around the cycle. In addition, stocks may not repeat the cycle because of merger, acquisition or bankruptcy. The different stages on the Earnings Expectations Life Cycle are discussed below.