Peter Lynch was often keen to remind investors that “behind every stock there’s a company.” It seems obvious, but it can be easy to lose sight of the fact that stock prices are a direct reflection of the real companies they represent. Appreciating this fact can help dispel the misconception that the “stock market” is a monolithic entity that moves up or down solely based on the latest economic or political news.
Rather, investors are constantly adjusting their expectations about how well or poorly individual companies will perform in the future and therefore, what the appropriate value of their stock price should be today. Quarterly earnings reports are a key tool that helps investors regularly assess a company’s progress.
This ritual is currently underway for companies with fiscal quarters ending December 31. Earnings reports to date have been sending mixed signals about the US economy across differing industries. GM recently reported strong earnings that exceeded expectations, and management announced the company’s optimism for the year ahead. Conversely, UPS reported weaker than expected earnings and announced significant layoffs as they expect fewer shipments and slower profit growth in the year ahead. Investors scrutinized every number in both earnings reports as they tried to glean what comes next for these companies and for the broader market as a whole.
What Are Quarterly Earnings?
To be listed on a stock exchange, public companies must disclose a wide variety of financial information on a regular basis. These mandated quarterly earnings reports let shareholders and potential investors take a peek under the hood to see how a business is faring. It is essentially a quarterly report card for each business.
Earnings reports include three key financial statements: the balance sheet, the income statement, and the cash flow statement. Taken together, these documents provide an overview of sales, expenses, net income, and earnings per share. The results are typically filed with the SEC and made public within 45 days after the end of the company’s fiscal quarter. With more than 5,000 public companies that trade on US stock exchanges reporting every three months, the few hectic weeks where a majority of these reports are released constitute “earnings season.”
When a company announces its quarterly results, investors immediately compare the actual results to what financial industry analysts had estimated. After the data is released in quarterly or annual reports, analysts might upgrade, downgrade, or maintain their recommendations of a company’s stock – along with future price targets for the stock. This reconciliation of expectations versus reality can result in additional volatility during earnings season as investors recalibrate expectations for future growth in individual companies as well as the broad economy.
Balancing Short-Term Results and Long-Term Investing
What is the value of looking at the past three months’ data when you plan to hold the investment for many years, especially for an established and successful company? The stock market is forward-looking. Therefore, it can seem counterintuitive that forward-looking prices are so impacted by looking backward at prior results. Investors make decisions every day, bidding stock prices both up and down based on their changing expectations of a company’s future results. Quarterly earnings provide a chance to reconcile price movements with each company’s actual performance. The reports also let the investing public know if the company has performed better or worse than the company expected, which will also affect the share price. If a company reports financial metrics in line with expectations, it may not see its stock move much since investors had already priced in those expectations.
In addition to reviewing how well a company executed its plans, the other important element of these quarterly reports is the forward-looking guidance that company management shares. These comments are generally the most interesting information for investors. Given current uncertainty and the idiosyncratic factors facing each industry, the forward guidance that comes from the people who know the most about the company’s situation and prospects can move the stock price even more than the financial results from the past quarter.
As an interesting aside, companies beat or exceed their earnings estimates each quarter with astounding frequency. Over the past 10 years, companies in the S&P 500 have reported actual earnings per share that were above their earnings estimates approximately 74% of the time. This offers a reminder that companies want to under-promise and over-deliver. Missing the anticipated levels of either revenue or earnings can lead to a significant drop in the stock, both because management doesn’t seem able to forecast their own business results and investors have already priced a different outcome.
Filtering Out the Noise
At North Berkeley, we are focused on long-term growth rather than the ephemeral nature of short-term price swings. This means that we don’t put too much weight on any one earnings report or season, but we do monitor trends as they develop and incorporate them into long-term portfolio decisions. Our clients have broadly diversified portfolios consisting of hundreds and sometimes thousands of stocks, which means they are insulated from a negative surprise in any one company’s earnings results.
These snapshots of information along the way help investors to make portfolio adjustments and understand market trends. While there can be a negative impact on an individual company’s stock if they don’t get a good report card, quarterly results – no matter how good or bad – don’t change the long-term goal of staying invested in a well-diversified portfolio in order to grow your assets over time, outpace inflation, and provide financial security for an uncertain future.
About Brian Kozel, CFP®
Brian Kozel is a Partner at North Berkeley Wealth Management. Brian helps clients feel confident as they navigate their financial journey.
This commentary on this website reflects the personal opinions, viewpoints, and analyses of the North Berkeley Wealth Management (“North Berkeley”) employees providing such comments, and should not be regarded as a description of advisory services provided by North Berkeley or performance returns of any North Berkeley client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. North Berkeley manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.