By Matt Billings, SVP of Trading Services
Earnings season is a busy time in our markets because of how earnings results impact stock prices. Analysts, investors and traders all look for bits of information that might assist them in making informed decisions about the companies they follow. While data can always be interpreted differently, here are a few pointers to keep in mind during earnings season.
1. Earnings and Growth Estimates Drive Prices
Many valuation models are driven by expectations surrounding earnings, rates of return, interest rates and cash flows. With so much focus on forecasting, a good part of a company’s estimated value is driven off of things that haven’t happened yet. It’s a good idea to try and decide for yourself if you think the estimates are reasonable or overly optimistic. This in part is why a company can report good results but still see a drop in their share price (or report poor results but still see an increase in share price). If the market expected great news but only got good news, you shouldn’t be surprised to see subsequent price movement.
2. Small Changes in Estimates Can Have Large Impacts on Prices
Earnings estimates are a sensitive indicator so the slightest deviation off of expectations can have an out-sized impact. Many pricing models use a number of forecasts, so even minor changes can cause price dislocation. In some models, individual variables can be weighted to have smaller or larger impacts than other variables. This means a change in one variable could have a substantial impact on the predicted value of the underlying stock.
3. The Headline Numbers
Accounting rules can play a big part in reported earnings. Income statement reports breaks out operating results from other income sources. When analyzing the earnings reports yourself, look at operating results from the core business separately from other income items. It is possible that the headline earnings number was helped (or hurt) by other income sources that are not directly related to the core business. Accounting rules could also require reporting that skews the relevance of certain reporting items that might show up in the headline numbers. There are also one-time items that will impact earnings. Be sure to take into account how one-time items can impact earnings for the immediate quarter but not necessarily for the long-term.
Tip: Look beyond the headline numbers to figure out what’s actually happening behind the scenes.
4. Earnings and Future Guidance Can Act as a Leading Indicator
Most publicly traded companies have competitors within their industry. By following the competitors of companies you’re watching, you might pick up on challenges that are affecting the entire industry. Additionally, some companies are so large that their reported results can give clues as to the current status of the U.S. and global economy.
5. The Spin
Earnings conference calls start off in a scripted manner, and management teams have it in their best interest to frame things in a positive light. After all, management wants their earnings announcement to positively affect stock price.
It helps to avoid getting caught up in the tone of the conversation on the earnings call. Be critical of earnings numbers that come with little guidance or clarity. At the end of the day, the numbers are what tell the story. It is then up to you to decide how and if to act. Analysts and investors are able to make more informed decisions about the future of the company when they look at the big picture without buying into “the spin.”
Tip for Buy-and-Hold Investors
You’ll hear the advice to focus on the long-term; one quarter’s results aren’t necessarily significant. While you do want to stay focused on the long-term, significant events can happen in the short-run that have long-term implications. You’ll want to be aware of those changes to examine how deep the impact goes and what result they could have on the profitability of the core business.
Tip for Active Traders
Monitor the market action and know how it fits into your trading plan. Define entry and exit points that fit your risk/reward profile. Avoid forcing a trade because you feel like you’re missing the opportunity. New opportunities become available every day, so remain patient and wait for the opportunity that fits your overall strategy.
Read Next: Earnings Reports that Matter
No fault to the author of this article, but there is at least one essential aspect of the "earnings" situation which was not mentioned. That aspect is "FOR WHOM". The underlying theory of the relevance of "earnings" is that they inure to the benefit of continuing stockholders. Whether as increments to Net Tangible Equity or as cash distributions RATABLY to all stockholders is not important. Since 1987, however, when His British Lordship the criminal mastermind Greedspan began emphasizing the felony theft of the ratable property of continuing STUCKholders under the reinstated euphemism "stock buybacks" (which was used to de facto BANKRUPT vast swaths of formerly great companies prior to GREAT DEPRESSION ONE and was the real cause of the mass bankruptcies during the 1930s), those felony thefts have turned "earnings" into mere air ninnies. Fraudulent misrepresentations of "gain" for stockholders which are in reality turned over to criminal cronies of the munchiment (altered version of "management" to reflect the reality that they behave as grade school children engaged in a school cafeteria "food fight" slinging stockholders equity around as so many "munchies") via "stock buybacks" are no "gains" at all but frequently nothing but excuses for "financing" felony thefts and criminal purpose "borrowings" to put the resulting corporation further and further into de facto bankruptcy. No skin off the criminal munchiment's nose since the corrupt "bankruptcy laws" allow them to retain control of all of the assets during and after the bankruptcy filing. Severe skin off the wiped out cash paid public stuckholders when (not if) the thereby gutted and looted scam corporation ultimately files the same reports with the bankruptcy courts that have already been filed with the SEC.