If you are an investor you have probably heard the terms tailwinds and headwinds, but what exactly do they mean?
In this article, we will explain the meaning of this aviation analogy, and how tailwinds and headwinds are used in business and finance, while also providing you with some examples.
What is the meaning of tailwinds and headwinds?
Tailwinds and headwinds are commonly used in aviation. A Headwind means that the wind is blowing in the opposite direction of the plane. Tailwinds are the opposite of headwinds and it happens when the wind is blowing on the back of the aircraft.
Although these terms are mainly used in aviation, they are also used in finance and business.
What are headwinds in business and finance?
A headwind in business and finance means that there are events, and reasons as to why a company might experience poor financial performance. If a company has several tailwinds, there are reasons or subsequent events that can explain lower growth going forward.
What are examples of headwinds?
There are probably far too many examples of headwinds to name, but here are some of the most important:
- Insiders selling
- Negative views of the company
- Not meeting estimates
Although insiders selling does not have the same impact as insiders selling, because it can happen for many reasons, it can still be considered a headwind. Insiders know a lot more about the company than any investors or analysts. Therefore, if they are selling their ownership of the company, it could mean that there are plenty of headwinds ahead.
Legislation can also be a headwind. The government may pass a certain piece of legislation that could negatively affect a business. This is an example of an external headwind the company and its management have no control over.
If the economy is struggling, and this is affecting the business, it can be considered as a tailwind. For example, a recession is a headwind for luxury goods companies. Since the demand for their products is lower.
Trends can also have a direct impact on the company. For example, the recent renewable energy trend is a headwind for fossil fuel companies like coal mines, and oil refiners.
Not meeting estimates
A stock that is unable to meet analyst estimates frequently could be seen as a headwind. It could be a hint that something internally is wrong, and it could be an example of an internal headwind.
It is undeniable the effect a great management team can have in a business. However, it can also have a very negative effect if the management is not taking the best decisions for the business. This can be an example of a headwind. Additionally, a change in management can also be either a tailwind or a headwind.
What are tailwinds in business and finance?
Tailwinds are the opposite of headwinds. They represent events and reasons why the business performance might be better going forward. If a company has several tailwinds, it means that there are several factors that can push its growth.
What are examples of tailwinds?
Here are some of the main examples of tailwinds:
- Insiders buying
- Beating estimates
Insiders buy when they feel the stock will move higher. This is usually a great tailwind, and it signals that the stock should rise in the near future.
Although legislation can be a headwind it can also be a tailwind. For example, the recent push for renewable energy has been extremely beneficial for several companies in the industry, and that is indirectly connected to it.
Economic growth can also be an example of a tailwind. For example, if the GDP is growing, consumer spending is expected to increase. This can be considered an external tailwind for several stocks in the consumer discretionary sector.
Trends can also have a very positive impact on businesses, and therefore can be either considered a tailwind or a headwind.
A stock that constantly beats analyst estimates has a great tailwind. Analysts are expecting the company to continuously beat all of the estimates regarding its financial performance. This creates a situation where the company is expected to keep delivering growth.
Management is certainly one of the biggest influences on how a business performs financially. Having the right management can be a huge tailwind for companies, especially in highly competitive industries, where they can really make a significant difference.
What's the difference between headwind and tailwind?
A headwind is an event or factor that will negatively impact the business, while a tailwind is an event or factor that will have a positive impact on the company. Headwinds, as well as tailwinds, can both be directly related to the company, and its management or they can be external factors.
External and internal winds
It is important to make the distinction between internal and external tailwinds and headwinds. Businesses might be influenced by internal reasons, or external and both can be perceived as tailwinds or headwinds.
What is an internal tailwind?
An internal tailwind is a reason or even that could push the business to grow. Some examples include a change in management, or the release of a new product, as well as some internal corporate changes that could make the business grow.
Usually, companies have a lot more control over internal tailwinds, and their ability to create them can influence the growth they achieve in the long term.
What is an external tailwind?
An external tailwind is when events or reasons that are not fully controlled by the management or the company can be beneficial. For example, an oil company witnessing a rise in oil prices is an external tailwind.
External tailwinds can also be related to legislation or markets trends that are not influenced by the company, but ultimately benefit the business.
What is an internal headwind?
An internal headwind can usually be associated with poor management of the business. Internal headwinds are much easier to tackle than external ones because the company has direct influence over them. With external headwinds, the company does not have any ability to prevent such events from happening.
What is an external headwind?
An external headwind represents events or factors that negatively affect the business, but that the company or its management has no control over. These usually include legislation that could impact the business, as well as commodity prices, and trends.
Since the company or its management does not have any ability to influence external headwinds, the only thing they can do is to try and mitigate them.
It is important to understand the distinction between headwinds and tailwinds, and how they can affect businesses. Moreover, understanding the difference between external and internal factors that create tailwinds and headwinds for companies will also give you an advantage when investing in the stock market.
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