Earnings Expectations Life Cycle

A company’s stock rises and falls based on a variety of factors, such as expected earnings. We’ve plotted the “theoretical” earnings expectations of a typical company on a clock face to illustrate the differences between managers who favor the “Growth” investment approach and those who utilize the “Value” approach:

	12 o’clock: The company’s earnings are high and expectations are as high as they can get. 1 o’clock: Following a negative surprise, the stock begins to lose some of its luster. 3 o’clock: Analysts revise earnings estimates downward and often drop its ratings from “buy” to “hold.”
	4 o’clock: Earnings expectations continue to fall dramatically. During this phase the company may be considered “controversial” and many will hold negative opinions. 6 o’clock: Earnings expectations reach their low point. In theory, there is little down-side risk as expectations are as low as they can get.
	7 o’clock: There is a positive earnings surprise. Positive surprises may recur for several consecutive quarters. 9 o’clock: Analysts begin to revise their earnings estimates upward, and expectations elevate accordingly.
	11 o’clock: Everyone is jumping on the bandwagon – favorable public opinion and positive press contribute to the company’s position as a “Wall Street darling.” 12 o’clock: The cycle begins again as the company’s earnings are high and expectations are as high as they can get.

While both investment approaches look for stock prices to increase, Value managers typically operate in the lower half of this clock, while Growth managers favor the top half.

Value managers try to purchase companies as close to 6 o’clock as possible and before a positive earnings surprise. Value managers will usually sell companies at 9 o’clock, at what they believe is fair value. The risk of value investing – as it is impossible to predict the bottom price – is buying too early.

Growth managers try to purchase companies that have exhibited consistent earnings growth over several quarters. They are willing to pay higher prices for this consistency and strive to find companies that are able to sustain the growth for lengthy time periods. The risk of growth investing is being late to sell, as it is impossible to predict the peak price.

Both styles have proven to be successful over long periods. Many experts recommend that investors diversify their investments to include more than one traditional styles.