Publicly traded companies are required to report their financial results to regulators and shareholders on a quarterly basis. Earnings season is the often-turbulent period during which most companies must disclose their successes and failures.
An earnings surprise — whether profits come in above or below the stock market’s expectations — can have an immediate effect on a company’s stock price, so it’s easy to understand why executives may go to great lengths to impress Wall Street. Over the long run, companies listed in the S&P 500 have “beat the street” about two-thirds of the time. 1
It’s generally true that earnings are a key factor in stock performance over time. However, a negative or positive earnings surprise is not always a reliable indicator of a company’s longer-term outlook. Here’s a closer look at the information that is presented to investors during earnings season.
A quarterly report typically includes unaudited financial statements, a discussion of the business conditions that affected financial results, and some guidance about how the company expects to perform in the following quarters.
Financial statements point to the quarter’s profit or net income, which must be calculated according to Generally Accepted Accounting Principles (GAAP). This typically involves subtracting operating expenses (including depreciation, taxes, and other expenses) from net income.
Earnings per share (EPS) represents the portion of total profit that applies to each outstanding share of company stock. EPS is often the figure that makes headlines, because the financial media tend to focus on whether companies “meet,” “beat,” or “fall short of” the consensus estimate of Wall Street analysts. Using this narrow measuring stick, a company can beat the market by losing less money than expected, or can log billions in profits and still disappoint investors who were counting on more.
Moving the Goalposts
In addition to filing regulatory paperwork, many companies announce their results through press releases, conference calls, and the Internet so they can try to influence how the information is perceived by investors, analysts, and the general public.
To help avoid surprises, many companies take steps to manage the market’s expectations. This may be accomplished by issuing profit warnings or positive revisions to their previous forecasts, which may prompt analysts to adjust their estimates accordingly. Companies may also be able to time certain business moves to help meet quarterly earnings targets.
Earnings figures are watched closely because they represent a corporation’s bottom line, but they also generally reflect past performance. Wall Street tends to be forward looking, so there are other important events that can affect prices over time. Sales performance, research and development, new products, consumer trends, and changing economic conditions can affect a company’s future prospects.
The return and principal value of stocks fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost.
The media hype surrounding earnings that come in stronger or weaker than expected can sometimes draw attention away from other important details that may be included in a company’s quarterly report. Understanding how the reporting process works may help you keep short-term market swings in perspective and remain focused on a thoughtful investing strategy based on your financial goals, risk tolerance, and time horizon.
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1) Kiplinger.com, July 15, 2011
The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright © 2013 Emerald Connect, Inc.