Earnings season: ‘tis the season to be jolly

5 minute read

The most wonderful time of the year

Earnings season refers to the four months of the year–January, April, July, and October – when quarterly corporate earnings release to the public.

It's the busiest time of the year for people interested in the markets as every large publicly-traded company essentially issues their report card: results of their last quarter. These results have a lot to do with the performance of shares, which is 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 dial in and listen to executive teams detail company results for that particular quarter and use it as an opportunity to discuss the context of their results. Topics range from discussion of financial performance to management changes, and much more.

Earnings provide an overview of how much money a company is making and will give investors like you good insight into investment opportunities. Earnings are arguably the most important driver of individual share performance over the long run — and by extension, the overall share markets. If the majority of companies, particularly the established market leaders, are growing their sales and earnings, investors tend to feel more confident about future market prospects. On the other hand, when earnings are below expectations, it can be a warning sign of potential trouble ahead.

Ring the bellwethers

As earnings season ramps up, analysts conduct 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 factors such as financial statement analysis and ratios.

As an investor in the US share markets, you want to pay attention as this a hugely busy time in the markets with everyone reviewing these earnings reports to see what’s what. You’ll see much 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, but they can fall by this amount too. Earnings season can be when the market at its most exciting, which can mean most volatile. Media do a great job of reporting on earnings releases, and you’ll quickly see if companies have missed, met or beat 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 an unfavourable market response eventually recover after 30 days and most with an average return of 6.14 percent.

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

Factors that affect earnings

Earnings influence a company’s share price. By knowing the potential impact an earnings report can have on a share beforehand, investors can brace themselves with the right knowledge to invest confidently.

Here’s some food for thought:

1. Earnings matter in relation to market expectations

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. Before an earnings report is announced, analysts are polled in advance and asked what figures they are expecting. The media takes the average from analysts and releases the forecast numbers to the public. The market then, in turn, takes the forecast numbers and factors them into the price of the share. The market will react accordingly if earnings are worse, slightly better, or if they beat expectations.

2. The quality of earnings matter

Earnings come around every three months, so to get a sense of where they're going, pay attention to companies with quality earnings: earnings that are consistent and sustainable. Look at things like net profit and cash flow to get an idea of the overall earnings picture. By considering a few factors, you can quickly assess earnings credibility, and identify any risks if there are any.

3. Cash flow matters

Earnings only tell part of the story of a company's investment-worthiness. Cash flow is a measure of the actual money that's available after capital expenses can be one of the best ways to tell what's lurking beneath a company's earnings report. Free cash flow can provide you with an indication of a company's resources for investment, dividends, and acquisitions (in other words, growth).

4. Management matters

Management teams often offer guidance for future periods when they announce results such as sales outlook, revenues, and other factors from the prior quarter. Guidance can affect share prices; 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.

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You’re an investor, so you should care

A company's earnings, or profits, are an indication of a company's financial health. In the end, growing earnings are a good indication that a company is on the right path to providing a good return for investors. To compare the earnings of different companies, investors and analysts use the ratio earnings per share (EPS). EPS is the portion of a company's profit that is allocated to each outstanding share of its common stock. Although it is important to remember that investors look at all financial results, EPS figures of companies attract the most attention and media coverage.

Investors care about earnings because they drive share prices. Strong earnings often result in the share price moving up. There are, however, no guarantees that the company will fulfil investors' expectations, so keep that in mind when you're looking investment opportunities.

The bottom line is that earnings season is an exciting time that plays a significant role in the performance of most share prices, so it's a good idea to pay attention when the companies you're interested in issue their reports.

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