There is a generally accepted rule of thumb on Wall Street: Positive surprises are good and negative surprises are bad. And the stock market is the ultimate field where this rule is seen in action when companies report financial results or other important business developments.
The playbook is painfully simple. Analysts come together and develop a consensus estimate of a company's earnings. If a company reports results that are better than the consensus, it's highly likely that the underlying stock price will pop higher; if a company disappoints expectations, then you can expect the stock price to fall.
It should come as no surprise that many companies usually deliver earnings that are very close to analysts' estimates. More so, if a company believes it can surprise positively, it will bust its tail to do so. On the other hand, companies will move heaven and earth to ensure that they do not disappoint on the downside.
Last week, The Wall Street Journal exposed that analyst/company relationship in an article titled, "Firms Steer Analysts to 'Surprises.'" It wasn't a pleasant article for the individual investor. Barry Diller, chairman of Expedia (EXPE) , referred to the relationship between analysts and corporate investor relations departments as a "rigged race." According to an analysis by the WSJ, immediately after quarters end, earnings estimates at companies start trending lower in attempt to avoid an embarrassing earnings "miss" and, they hope, turn it into a surprise.
The article goes into more specific detail, but I think you get the gist. But my conclusion is not that the stock market is rigged or that investing is a fool's errand. On the contrary, the stock market remains a wonderful money-making machine for those who approach it intelligently and rationally. This approach begins and ends with a couple of simple observations that Benjamin Graham made.
No. 1: An investor is neither right nor wrong because the market agrees with her, but rather right because her data and reasoning are right.
No. 2: In the short run, the stock market is a voting machine and in the long run the stock market is a weighing machine (read: short-term market movements are meaningless unless they give you an excellent time to buy or sell).
No. 3: Investing, by definition, is a process that, after diligent research and analysis, involves the purchase of securities at a satisfactory margin of safety. All other endeavors are speculative.
In other words, you can't invest successfully unless you do your own due diligence. Whether you are analyzing a single stock or an investment manager, the process is still the same. Don't blindly take another's word for it. Be your own analyst.