Baked in the Cake: What It Means, How It Works, Example

What Is Baked in the Cake?

As a phrase, "baked in the cake" is used to indicate that some material information, such as unverified news reports or earnings projection, has already been taken into account and included in a security's market price. An investor just learning the news is unlikely to be at an advantage by acting on it, as the price has already moved to reflect the upcoming information.

"Baked in the cake" may also refer to a complex situation with many intertwining factors that cannot be separated from one another or a current or impending situation that cannot be solved or avoided. For example, one might say that a looming, unavoidable recession is baked in the cake; one might also explain that long-term unemployment is baked in the cake in terms of the economy.

Understanding Baked in the Cake

Investors who try to profit from breaking news must answer a difficult question: How many other investors have already acted on the news, before, at, and after its release? This fundamental issue is related to insider trading and asymmetric information.

To profit from breaking news, an investor must be one of the first to hear of it. Once a critical number of investors have traded on an earnings estimate, the news will be considered baked in the cake, meaning the news will have already influenced the stock’s market price. And investors who hope to profit from taking action on this information have instead obtained it too late.

However, this isn't always necessarily true. While there may be an initial reaction to the news, it can take traders days and weeks to accumulate or dispose of positions. So trends can last much longer than the moments immediately following a news release.

Investors should be careful about what news they trade on and where that news is coming from. The advent of the internet has increased the availability of information, but the source and veracity of the information found on the internet are difficult to ascertain.

For example, if an investor is told material, non-public information by an employee of a company, trading that company’s shares may lead to an investigation by the Securities and Exchange Commission (SEC), as acting on non-public information to make a profit from investing in that company may be illegal insider trading.

In addition to concerns about the source of information found online, investors need to consider that information gleaned from online sources may already be baked in the cake.

Example of Baked in the Cake

Assume that the official forecast for the Abercrombie & Fitch Co. (ANF) quarterly earnings is $1 per share. The whisper number is $1.25, meaning traders expect much higher earnings than what the analysts are officially forecasting. The analysts may even believe this, but they don't want to be too optimistic and look foolish if they are wrong.

The stock may have already rallied to reflect the $1.25 expected number after heading into the earnings announcement. If the earnings come out at $1.25, there may be some volatility, but the market got what it expected, so there may not be much price movement. The announcement was already baked in.

If it comes in at $1, the stock may plummet, even though it is in line with analysts' official forecasts. If earnings come in at $1.75, that surprises most everyone, and the stock is likely to jump. These alternate scenarios are bigger surprises, so it will take some time for the price to adjust and bake in the new information.

Special Considerations

The whisper number is what traders, investors, and analysts think the number will be on a news release. This may vary from the official public forecasts of the analysts.

Knowing the whisper number can help determine what is likely baked into the cake/price already. If a trader has an idea of what other traders are expecting and how they will react to the news, this may provide them with an edge, especially if the news is different than expected.

Whisper numbers are found via how traders are positioned in the days leading up to an announcement, through surveys, sentiment indicators, and through the general chatter on social media—are traders optimistic, pessimistic, or aloof? All these states may help indicate what way the price will move based on what the actual news number comes out as.

The price has current expectations built into it, but people who placed bets on a particular outcome end up being wrong if something changes that expectation. The price will move to reflect that new information. Eventually, that information will be bake in too.