×

Yoshikami: Earnings Estimates are Merely Guesses

It's earnings season again and time to assess the efforts corporations are making in dealing with the great recession of 2009. Investors and analysts alike have predictions about who will win and lose in this earnings season.

But as you keep score, it's important to have a healthy dose of cynicism; earnings estimates are merely guesses. Measured guesses, but still just educated speculations about the past and future.

Stock chart
Stock chart

An estimate is really just an analyst's projections about corporate financial health and the predictions often vary significantly. Estimates are influenced by company philosophy, individual analysts perspectives, psychological baggage from being wrong in the past, and the desire by most to stay fairly close to consensus numbers (being much different on your numbers carries a risk).

The truth is, despite efforts to the contrary, earnings projections are invariably tainted with a degree of bias and subjectivity; they are not perfectly objective.

To assume these numbers are wise and accurate without carefully assessing the context in which these decisions are made would be a mistake. But thats exactly what most investors do.

This is not to say that analysts estimates are not a valuable tool in assessing the attractiveness of investment; they are an important component of the decision process.

And in the end, prices of assets are measured based on current and future cash flow. Estimates come from professionals doing their best to be objective and are helpful in assessing the cash flow outlook for companies.

That effort should be respected (and cautiously digested) as long as one recognizes that there are no perfect outcomes; bias always exists.

So as an investor, carefully think through the philosophy underpinning recommendations and projections. Don't optimistically trust without thoughtful reflection.

Ronald Reagan once said about the then Soviet Union, that he was willing to "trust" but only with simultaneous verification The former president knew that it was important to be academic in perspective, hopeful in expectations, and to avoid trusting blindly.

Take the same advice as you watch earnings season this quarter. It will help you make sense of the numbers, the market's reaction, and what your next moves should be as an investor.

Trust but verify; a healthy perspective and one that can benefit you as an investor.

___________________

yoshikami_michael_100_2011.jpg

Michael A. Yoshikami, Ph.D., CFP®, is Founder, President, and Chief Investment Strategist of YCMNET Advisors, Inc., a registered investment advisory firm (www.ycmnet.com). He oversees all investment and research activities of YCMNET. He is a respected lecturer speaking frequently on market issues, tactical asset allocation, and investment strategy. Michael and YCMNET were ranked as one of the top investment 100 advisors in the United States for 2009 by Barrons. He appears regularly on CNBC and CNBC Asia and can be reached directly at m@ycmnet.com.