It’s that time of year when the markets can’t stop crowing about earnings, but what does that mean for everyday investors?
Earnings season is essentially the time of year when companies come home with their school report cards (quarterly earnings) to show the markets how they’ve performed during the last quarter. The ‘season’ begins two weeks after the last month of each quarter and lasts roughly six weeks. But why do investors make such a fuss?
Earnings and revenue numbers are the best predictor for potential future growth in a company’s share price. This means that positive and negative results will have a big effect on buying and selling activity (volume) as investors pile into or out of certain stocks to benefit from their future profits or losses.
Why should I care?
Coming up to these earnings announcements, analysts offer their estimates and recommendations for the investor community. Investors then take these judgements and buy or sell stock according to the beliefs about whether the company will outperform or underperform these estimates.
For example: Ford consensus earnings per share (EPS) estimate is $0.32 based on forecasted revenues of $38.66bn.
We all know that markets react explosively to surprise events. Well, when a company beats or misses its earnings estimate by quite some distance its share price goes wild. Beating EPS and revenue estimates results in a sizeable share price appreciation while an earnings miss brings about a depreciation.
For example: if Ford’s actual EPS is announced at $0.45 (40.6% above the original estimate) and revenue is $39.30bn (1.66% above the forecast) then the estimates would have been beaten comprehensively and Ford’s stock price would more than likely increase dramatically – unless a warning of future bad tidings had been baked in!
Investors take these reports very seriously because at the end of the day a company’s share price is just a reflection of its performance and health. Quarterly updates allow you as a long-term investor to make sure the company is still on track to grow year-on-year and keep generating positive returns for your portfolio.
The long and the short of it
While many short-term traders get caught up in the violent swings that happen around these reports, long term investors should hardly be bothered by intraday price fluctuations. Instead, rather focus on the data itself for its value as a forecasting tool for longer time horizons and smooth out the short term bumps in the road.
Earnings season is a great time to do some shopping for companies with strong fundamentals to add to your portfolio. It’s also good practice to also listen out for large companies within each sector to use as a benchmark for each sector’s performance. Noticing trends in each sector is an important part of investing and making sure you have exposure in the right areas of the market to get the best possible return.
