Expectations and surprises

In simple terms

A share price is not a reward for past results. It reflects what investors expect the company to earn in the future. So when news arrives, the question that matters is not "is this good or bad?" but "is this better or worse than expected?"

Good news that everyone expected is already priced in. Bad news that was less bad than feared can lift a price.

Consensus and surprises

For listed companies followed by analysts, data providers average the analysts' forecasts into a consensus estimate for revenue, profit and earnings per share. Economists' forecasts for inflation, GDP or policy decisions are averaged in the same way.

A surprise is the actual figure minus the consensus.

Price reactions also depend on what the result implies for future quarters. Management's comments on demand, costs and plans often matter more than the past quarter's numbers, as the earnings season lesson explains.

The same idea in economic data

Bond yields, the rupee and share prices react to economic releases compared with forecasts. If economists expected inflation of 5.2% and the figure is 5.0%, bond yields may fall even though inflation is still high, because the lower-than-expected figure changes expectations for interest rates. A rate decision that everyone expected may barely move markets, as the monetary policy lesson explains.

"Buy the rumour, sell the news"

When investors expect good news, such as an index inclusion, a big order or a favourable policy, they buy in advance and the price rises. When the news is confirmed, there is nothing new left to buy on, and some investors take profits, so the price can fall on the "good" news.

The opposite happens too: prices often fall ahead of feared bad news and recover once it is announced and turns out to be no worse than expected.

Explanations after the fact

Every day, headlines explain why the market rose or fell. Many such explanations are guesses written after the event. Signs to be careful:

• The same cause is used to explain opposite moves on different days.
• The story fits the move perfectly, but nobody predicted the move from the story.
• Many things happened that day, and one is picked as the cause.

Our minds like neat stories, and hindsight makes outcomes seem obvious, as the decisions and outcomes lesson discusses. Many daily moves have no single clear cause, as the reading market news lesson explains.

What this means for investors

• Know what is expected before judging news.
• Do not chase news after it is public; it is usually already in the price.
• Focus on long-term business value, where your analysis can differ from consensus, rather than on predicting the next surprise.

Why it matters

Understanding expectations explains puzzling market reactions: falls on record profits, rallies on losses, and calm on news everyone was talking about. It also guards against trading on headlines that are already reflected in prices.

Limitations

Consensus figures are imperfect measures of expectations: some analysts' forecasts are stale, and investors may have different "whisper" expectations. Price reactions also depend on positioning and broader market moves on the day.

Common mistakes

• Judging news as good or bad without knowing expectations.
• Buying after good news is announced.
• Believing every post-move explanation.
• Treating consensus estimates as accurate predictions.

Try it yourself

1. Before a company you follow reports results, find the consensus estimates.
2. After results, calculate the surprise for revenue and profit, and note the share's reaction.
3. Read the management commentary and note whether it changed the outlook, and how that matched the reaction.