Earnings season: ‘tis the season to be jolly

10 minute read

The most wonderful time of the year

Earnings season refers to the 4 months of the year–January, April, July, and October – when quarterly corporate earnings are released to the public. It is important to note that not all companies report during earnings season because the exact date of an earnings release depends on when the given company's quarter ends. As such, it is not uncommon to find companies reporting earnings between earnings seasons.

It’s the busiest time of the year for people interested in the markets as every large publicly-traded company reports the results of their last quarter. These results have a lot to do with the performance of shares, which is precisely why investors should pay attention during these months. Keen to read the reports? Ok, reports can be, um less riveting than expected, which is why CEOs and their teams set up earnings calls where you can literally dial in and listen to executive teams detail company results for that particular quarter. Topics range from discussion of financial performance to management changes, and much more. You would’ve heard about Elon Musk’s earnings call last May? It resulted in Tesla shares dropping 6.4 percent and personally cost him $300 million. Ouch.

There are plenty of different ways for companies to use earnings season wisely, but most use it as an opportunity to discuss the context of their results. For instance, some analysts will calculate earnings before tax (EBT) while others prefer earnings before interest and taxes (EBIT). Analysts working in industries with high levels of fixed assets, such as telecommunications, prefer to see earnings before interest, taxes, depreciation, and amortisation (EBITDA). While their acronyms might be different, all three measures provide an overview of a company’s profitability and will give investors like you good insight into which companies you should and shouldn’t be investing in.

Ring the bellwethers

As earnings season amps up, analysts conduct intrinsic valuations to determine the value of a share: is it over- or undervalued? These valuations help give investors an idea about whether or not to purchase, sell, or hold the shares in question. To come up with these valuations analysts look at a company’s qualitative aspects (i.e. business model, governance, and industry factors) and quantitative aspects such as financial statement analysis and ratio aspects.

As an investor in the US share markets, you want to pay attention as this a hugely active time in the markets with everyone reviewing these earnings reports to see what’s what. You’ll see a lot of movement in the shares of companies releasing their reports as the market reacts to this new data in real time. Expect to see shares jump 20% and more, just know they can fall by this amount too. This is the market at its most exciting, most volatile. With all of the media coving and reporting on the major earnings releases, you’ll quickly see if the companies you invest in have missed, met or beat your expectations. Yes, market reactions are par for the course, but any negative impact on share prices is usually short-term. Shares that lose value as a result of negative market response eventually recover after 30 days and most with an average return of 6.14 percent. Hold on to that buy-and-hold strategy and you’ll be sweet.

The bellwethers of their respective industries (financial, insurance, and tech) lead the way through the season. Well-known companies such as JPMorgan Chase, United Health Group, and Intel (INTC - Free Intel Stock Report) are three of the earliest reporting companies, and their effect on the market is huge. For instance, if any of these companies issue a negative surprise, individual shares will plummet, taking the market with them. As a rule, and to weather any negative results, most businesses report their quarterly results either before the share markets open (7am Eastern Time), or after the market closes (4pm EST) to give as many investors as possible the time needed to react to and to act accordingly, before trading gets underway.

Factors that affect earnings

It pays to research shares that report significant quarterly earnings growth because this can possibly lead to more earnings surprises in the subsequent quarters. Yeah, negative market reactions from earnings reports can affect share prices on short-term basis, but positive earnings surprises can help you identify potential shares to invest for the long-term

Here’s some food for thought:

1. Earnings matter - particularly in the long run

Earnings drive a company’s share price. While there are plenty of factors that affect share prices such as interest rates, FX, taxes, elections and geopolitical events, these influences are mostly transitory. Be patient and focus on your buy-and-hold strategy.

2. Earnings matter in relation to market expectations

Ok, so you own shares in a company that just reported 15% increase per share in earnings. How are you supposed to know whether or not this is a good result (besides the fact that your money just increased)? A lot of the success of earnings depends on what the market expects. When investors evaluate a company’s earnings announcement, they compare it with the market expectation, also known as the average earnings estimate that is forecasted by analysts who follow the company. Analysts evaluate recent corporate trends, talk to a company’s management and competitors, and incorporate guidance from management to make projections about revenue, expenses, tax rates, and shares leading to an estimate for future earnings. Technically, a share’s price incorporates all this information and what analysts expect the company’s future earnings to be.

3. The quality of earnings matter

Earnings come around every 3 months, so to get a sense of where they’re going, pay attention to companies with higher-quality earnings. Higher-quality earnings are more consistent and sustainable. Look at things like revenues, inventories, accruals, and cash flow to get an idea of the overall earnings picture. By considering these metrics, you can easily assess earnings credibility and profitability, and identify any risks if there are any.

4. Cash flow matters

Earnings tell part of the story of a company’s investment-worthiness, but sometimes the story being told is the one that management wants to tell. Cash flow, however, is a measure of the actual money that’s available after capital expenses, isn’t as easily malleable, making it one of the best ways to tell what’s lurking beneath a company’s earnings. Free cash flow is not as easily manipulated by management and can provide you with an indication of a company’s resources for investment, dividends, acquisitions, and share buybacks.

5. Management matters

Management teams often offer guidance for future periods when they announce results such as sales outlook, tax rates, and other factors from the prior quarter. Guidance can affect share prices as much as an earnings surprise, in fact, it’s rather common for a company that reports strong guidance to see its share price rise even when its reported results miss market expectations. Weak guidance can also affect a share, albeit negatively, even when it accompanies a positive earnings surprise.

You’re an investor, so you should care

Fact: investors care about earnings because they drive share prices. So, strong earnings often result in the share price moving up (and sadly, vice versa in certain cases). While a company with a rocketing share price might not be making heaps of money, the rising price means that investors are expecting a certain level of profitability in the future. There are, however, no guarantees that the company will fulfil investors' current expectations, so keep that in mind when you’re looking for companies to invest in.

Speaking of looking at companies to invest in, earnings are an indication of a company’s financial health. Earnings are the money that a company makes and is evaluated by earnings per share (EPS). When you look at the reports check to see that a company’s earnings are growing: if so, the company you’re looking at investing in is more likely to provide a solid return for its investors. Quarterly earnings reports are vital financial updates that provide you with a glimpse into how shares will be valued in the future.

Just because some shares tumbled due to disappointing earnings, this doesn’t mean that they’re bad investments. They can actually be an attractive buying opportunity as long as you know what you’re getting in to. Take a look at any share price that has fallen considerably, and look beyond the earnings. If sales are continuing to grow in market segments, the fundamentals might be solid enough that you can anticipate the share price to rebound once the company makes the necessary changes to perform better in the next quarter.

The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed, or relied on, as a recommendation to invest in a particular financial product or class of financial products.You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any investment decisions.

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