During earnings season - the time when companies publicly report their results from the last quarter - many whisper numbers can be heard floating around Wall Street and on the Internet. It can be a period of extreme stock market volatility; the companies that don't meet earnings estimates are usually hammered hard, and experience a decline in share price. However, even companies that meet earnings estimates can suffer if they don't match the seemingly mysterious whisper number. What are whisper numbers? Where do they come from? We'll attempt to demystify the whisper number, and evaluate its importance to you as an individual investor. (To learn more, see 5 Tricks Companies Use During Earnings Season.)

TUTORIAL: How To Analyze Earnings

Earnings Estimates
When a company releases its earnings, any increase or decrease in its profitability is secondary to how well the company fared compared to investor expectations. This is because a stock's price almost always takes into account all future information. In other words, how well (or poorly) a company is expected to do is already built into a stock's price. For example, the market will punish a company that is expected to grow earnings by 20% if actual earnings only increase by 15%. Conversely, a company that's expected to grow 10% but expands 12% will be rewarded. This phenomenon occurs because future earnings are the driving force behind share price valuations. An unexpected earnings surprise for a company's current quarter will very likely have far-reaching effects on earnings forecasts for many years to come, and can significantly change how investors calculate the present value of the company's shares. (For further reading, see Getting The Real Earnings and How To Evaluate The Quality Of EPS.)

It is not surprising, then, that most analysts spend the majority of their time trying to make an exact prediction of a company's future earnings, called forward earnings. Surprising or disappointing Wall Street estimates by even a few cents can have a dramatic effect on a stock. If a large brokerage firm can make a prediction that is even one cent more accurate than that of its competitors, it stands to earn a lot of extra money.

Taking things one step farther, there are companies out there that do nothing but sell earnings estimates to institutional investors. Their job is to contact as many brokerage firms as possible and get quarterly earnings predictions from each firm's analysts. The estimates that you see in the newspaper, online or on TV are usually compiled by these firms, and are often reported as an average, or what is called a consensus estimate. Often, when you read the consensus estimate you will see that the highest and lowest estimate values are also reported - this can give you a sense of the variance of analysts' estimations. Large proportional differences between the high and low estimates generally indicate greater uncertainty about a given earnings report. (To read more about earnings estimates, see Earnings Guidance: The Good, The Bad And Good Riddance?)

The Whisper Number
Even after plenty of research, however, consensus earnings estimates often still aren't that accurate. An explanation might be that there just aren't that many analysts covering the entire market. Large caps often have dozens of analysts, but there are plenty of mid-caps and small-caps who don't have any analyst coverage! On top of that, as news of the earnings estimate spreads, the game then turns to trying to predict what the discrepancy will be between the actual earnings and the estimates. (To learn more, see What Mutual Fund Market Cap Suits Your Style?)

This is where the whisper number comes into play. While the consensus estimate tends to be widely available, whispers are the unofficial and unpublished earnings per share (EPS) forecasts. In the past, these came from professionals on Wall Street and were meant for the wealthy clients of top brokerages. However, post Sarbanes-Oxley, the definition of whisper numbers has changed. You see, with all the regulations on Wall Street, you won't find analysts providing favorite clients with insider earnings data - the risk of getting in trouble with the SEC is just too great. (To learn more about the SEC, read Policing The Securities Market: An Overview Of The SEC.)

While over the past few years it has become more difficult (if not impossible) to get whispers from insiders on the street, a new type of whisper has emerged in which the expectations of investors as a whole (based on shared information, fundamental research and past earnings performance) create a sense of what to expect from a company, which spreads much like insider information.

In other words, the whisper now is the expectation from individual investors. The whisper is still "unofficial," if you consider the consensus estimate to be the "official" number, but the difference is that it comes from individuals, not from professionals. The source has also changed from your broker, to websites that put the whisper together.

The most obvious concerns here are manipulation of this "consensus" by investors who have a vested interest in promoting (or trashing) a stock.

Should You Follow the Whisper?
While the quality of the source of a whisper number is certainly important, whether or not you should take heed of a whisper mostly depends on what type of investor you are. For a long-term (buy-and-hold) investor, the price action around earnings season will, over time, be merely a small blip, making the whisper number a relatively trivial statistic.

However if you are a more active investor who is looking to profit from share price changes during earnings season, a whisper can be a much more valuable tool. Differences between actual earnings results and consensus estimates can have a significant effect on a stock's price. Whisper numbers can be useful when they differ (and of course, are more accurate) than the consensus forecast. For example, a lower whisper can provide a signal to get out of a stock you own before earnings come out. Also, whisper numbers certainly have a use when it comes to the large number of stocks that aren't covered by any analysts. If you are analyzing a stock with little coverage, a whisper number at least provides some insight into the upcoming financials.

There certainly is an ethical issue with what we referred to as the older type of whisper number. Let's assume that there are analysts breaking federal laws and providing you (or a website) with non-public information. Do you really want to take the chance with illegal data? While all investors are continually looking for a leg-up on the competition, insider trading laws are serious business - just ask Martha Stewart. (To learn more, see Should Insider Trading Be Legal?)

Whisper numbers used to be the unpublished EPS forecasts circulating around Wall Street, now they are more likely to represent the collective expectations of individual investors. For more active investors, an accurate whisper number can be extremely valuable over the short term. The extent to which this is important to you depends on your investing style. While whisper numbers aren't a guaranteed way to make money (nothing is), they are another tool that serious investors should consider.

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