Earnings season is around the corner once again, which means thousands of investors will be feverishly analyzing what their stocks report for last quarter against Wall Street estimates to see how their investments are doing. More and more investors, however, have likely been hearing a new additional figure being quoted by the financial media and analysts. That’s because over the past four years Estimize, the crowdsourcing platform for earnings estimates, has been quietly forging its way into the mainstream. It’s not quite there yet, but with over 20,000 analysts in its community and a reach of over 150,000 investors by their estimate, it certainly seems Estimize is here to stay.
Estimize boasts that its estimates are “more accurate than the Wall Street consensus 69.5% of the time.” Generally speaking, “Wall Street” consensus estimates (meaning a survey of sell-side analysts) has been historically off by about four percentage points from actual results, at least for the broader S&P 500, according to S&P Capital IQ. So, in other words, there is definitely a tendency for expectation to undershoot corporate earnings. Savvy investors have long since caught on to the trend, hence whisper numbers—the estimates that the secretive smart money and active market traders actually expect to see.
And what Estimize has managed to do successfully more than anything else is to get them to say it out loud.
Whispering Into a Bullhorn
There’s a widespread perception that on Wall Street, profits come from obtaining information that nobody else has. Secrecy and exclusivity is the modus operandi.
“It comes out of the 1980s,” said Leigh Drogen, Founder and CEO of Estimize. “There were some high-profile cases of insider trading and activist investing, and the belief was that you could only really generate alpha if you knew something that other people didn’t. Even recently, there are some funds that did that. But the vast majority of funds, analysts, portfolio managers, and traders who generate alpha do so because they are taking available information, analyzing it and executing on it differently than everybody else. They’re synthesizing various, vast amounts of information differently than everybody else, or better than everybody else.”
“My view of this entire industry has always been that that is what makes a good investor,” he added. “You synthesize information better than other people and then you execute on it better. I think that this view of the world has only really started to take hold among millennials, but even with some of the older guys in terms of statistics and Moneyball-like thinking; it has infiltrated finance.”
That shift toward collaboration didn’t come quickly. More than anything, Estimize can be credited for spearheading the acceleration of the movement. By developing the technology to actually aggregate and analyze that data, and then rolling up their sleeves to build out the community contributing to it, Estimize has been able to create something disruptive and unique.
Understandably, it did take some convincing. Estimize had to ensure that sensitive information remained secure and make sure that its “early adopters really understood that they were not at risk in any way of screwing themselves” by sharing proprietary information for nothing in return.
“I think naturally, all of these guys understand the concept of needing to understand where my expectation is in relation to the expectations of my peers,” Drogen said. “You're trying to triangulate the distribution of expectations so that you understand when a company reports, did it really beat the expectations of the guys who are actually going to be moving the stock versus the sell-side stuff? They were already doing this on [earnings] calls. The question was whether they were willing to actually put it on a website so that everybody could see the data, have it measured, be able to get alerts and notifications for this stuff. That was the real leap here.”
It’s Accurate, But So What?
Like many modern technology companies, Estimize is inherently social. It’s built on the concept of a collaborative community interacting through technology. And as is typically the case with new technologies, the early adopters were primarily made up of amateur enthusiasts and independent professionals. But to Drogen, that helps to create a more comprehensive representation of the market, which in turn makes Estimize’s datasets even more valuable.
“I think the general understanding of the social science community is that just because there are a lot of amateurs does not mean that there aren’t the professionals,” Drogen said. “The interesting thing is I think people underestimate the value of the amateurs as well, especially when it comes to structured data points. Over the last couple of years, we've had to deal with the question of, ‘OK, maybe they can be more accurate than the Wall Street guys, but who cares about that because they don’t represent the market.’ That’s been a major knock on this whole social finance community.”
Estimize is addressing this perception in several ways. The first and most obvious step is proving that the data is credible and has value to investors, which the company is doing through more educational content, media validation, and academic studies. Another step was to continue to expand the user base, including not only the buy-side and smart money, but in all areas to create a data set that aims to be more comprehensive and representative of the financial market than what currently exists. But most importantly, Estimize also needed to—and still needs to—explain how its data could be used to generate the almighty alpha.
“Estimates are inherently derivative of price behavior,” Drogen said. “It is extremely, highly correlated with price behavior. A significant upward revision in the expectations for EPS of a specific stock is extremely highly correlated to the directionality in the market. The estimates that we gather do not necessarily say anything in and of themselves about the way that you should trade the stock. So we need to constantly educate people on it. As an example, if there's a 10% Delta between the Wall Street and the Estimize consensus, and the Estimize consensus is way above that, then it means that you should be trading in the direction of that Delta, and you should be buying that stock. This is not incredibly intuitive to everybody. We've spent a lot of time, a lot of money trying to educate people on how to use that data.”
Creative Destruction Hits Wall Street
But like anything that proves effective in investing, sooner or later, when enough people catch on, the advantage is arbitraged away. If and when that happens, what does that make of Estimize?
“The goal of the company, from the very beginning was to replace Thomson Reuters consensus,” Drogen said. “We set out to do this and there's no secret about it. [Thomson Reuters IBES] is the quoted dataset, and for good reasons. They're the cleanest. They’re the most comprehensive. They’re the fastest and they're the most trusted.”
While Thomson Reuters may be the gold standard Drogen is reaching for, he says their datasets only represent that of sell side analysts while Estimize is a better representation of the entire market. That said, the company has a long way to go to catch Thomson Reuters, which is massive on a global scale.
“Of course, that is not going to happen overnight,” he added. “An institution like Thomson Reuters IBES does not get supplanted overnight. It gets supplanted by chipping away at it year after year after year. We’re four years into it now and certainly we're not going to take the whole thing overnight. But I don’t see a reason why we shouldn’t take the whole thing eventually from a realistic or theoretical perspective.”
Admittedly, Drogen isn’t sure how Estimize and Thomson Reuters will co-exist, or even if the contrasting business models would make it possible.
“It’s a very difficult thing,” he said. “I’ll compare a little bit to Robin Hood, which is the free, online, brokerage mobile app. I love what they're doing because they are what I like to call an ‘economic terrorist.’ They are willing to burn that whole industry to the ground in order to take whatever is left. They’re just going to make the industry hyper-efficient, and they don’t really care if they make a lot of money. They want the whole market share. It’s very difficult for another brokerage to work with them because it's not congruent in any way–the philosophy or strategy…They kind of sit outside of this thing, burning the industry to the ground. I think we're in a similar situation here where we're never going to generate as much revenue as Thomson Reuters because our philosophy is inherently more open. We inherently give away more of that data for free, but we will cannibalize the entire industry just as Robin Hood is and take whatever is left.”
What’s Next for Estimize?
In terms of the platform itself, Estimize is already branching out to datasets beyond earnings estimates. It’s already added macroeconomic estimates, and is looking at international data, ETF revenue, small and mid-cap stocks, and experimenting with M&A expectations as well. To create the data liquidity (sizable volume of contributor estimates) it needs, Estimize incentivizes its community with contests and challenges. It's also trying to increase the usage of its data around Wall Street and financial media, which results in added exposure and wider industry adoption.
"We just signed a huge deal with CNBC, who went through an extensive survey of our data," Drogen said. "We got a very deep probing of what was actually being done over here, and I think we signed this big deal and we're basically taking over the estimates on CNBC, CNBC.com and being referred as consensus. That doesn’t really happen unless they see that...you have a better data set, you have more representative datasets, you have people in the community who matter or that people perceive that they matter. It’s taken a long time to get there. It's taken a little bit more than four years of running the data set to get to the point where the media and [from the perspective of] the institutional buy side, a director of research or head of a fund and not just an individual analyst would want to get involved. We're really happy that this happened."
Bigger picture, Drogen also recently launched Forcerank—a daily fantasy game for the stock market and a separate legal entity from Estimize. Drogen thinks Forcerank could be even bigger than Estimize at some point from an actionable data perspective (more on that later).
“When you look at who is generating massive amounts of alpha in our industry,” Drogen said. “It's Rentech, it's World Quant, it's Two Sigma, it’s Point72, it's these massive, quantitative hedge funds that have no dogma whatsoever. They’re literally sucking up any and all data they can find that they believe will give them the ability to understand how people behave and how the market behaves in different situations.
“The question is how fast is the market going to adapt the Moneyball theory and dogma? The people who adapt it faster are going to be the ones that make money and the people who hold on to their old understanding of how people share, when they share and what data they should use, and who they should trust–those are the people are going to end up getting run over, and they are. They are getting run over.”
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