Understanding the Stock Markets – Earnings Season

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In our previous introduction to understanding the world’s stock markets we looked at the value of companies and touched on some of the things that make share prices move.

Unsurprisingly, when a company reports its earnings and other business particulars including forward outlook, share prices can move quite violently.

Major public U.S. companies are required to report quarterly, hence in the U.S. there are four ‘earnings seasons’ in a given year.

Results vs. analysts’ expectations

On the run up to each earnings season, stock market analysts are polled by leading polling companies as to what they expect each company to have achieved during the last financial period.

A company could have a bad quarter but if they surpass the analysts’ expectations their share price could still rise.  Conversely if a company misses the expectations of the analysts, then their stock price could fall dramatically, even if they achieved stellar results.

In this topsy-turvy world it is important to note what the expectations are. In the U.S., leading polling companies such as Refinitiv collate a large number of analysts’ notes and come up with an all-encompassing number for revenue and profit expectations. You can often find their results within news posts on financial websites such as cnbc.com

Additional factors for high-growth stocks

Companies that are growing typically have a higher premium built into their stock price than those that have a relatively static income. In the U.S., companies that are growing explosively such as Amazon, Tesla, Google and Facebook command a huge premium because their growth rate is high and/or may be accelerating. As soon as the growth rate falters then the premium may be seen as excessive and stocks can easily sell off. At the current time it is mainly high-tech stocks that command very high premiums as these are seen to have exceptional growth prospects.

Stock analysts are not only looking at profits and revenue. For companies that rely on a large user base they are also giving their opinion on how many new users should be added each quarter in order to maintain stellar growth.

Take for example the well-known movie streaming company, Netflix. It recently reported earnings per share of US$3.75, significantly ahead of analyst’s expectations of just US$2.97 (an almost 25 per cent beat), and exceeded the bar for revenue, achieving US$7.16 billion vs. US$7.13 billion expected. It also added 3.98 million new subscribers, but this wasn’t enough because expectations were for 6.2 million additions. The company’s shares plunged more than eleven per cent on the news even though it beat on revenue and earnings. Arguably the share price already had the good news baked in and the potentially lower growth was unwelcome.

Of course if growth stays on pace, or even accelerates at a higher pace then stock prices can rally strongly too. A substantially higher rate of profitability may also have a positive effect. Google (Alphabet) shares rose 4.8 per cent as the company announced earnings per share (EPS) of US$26.29 on revenues of US$55.31 billion against analysts’ expectations of just US$15.82 of EPS on revenues of US$51.7 billion. The premium was thus preserved with the stellar numbers.

For long-term investors, earnings seasons can be a time when they can reflect on their holdings or other positions in the market and make adjustments even if it is after some volatile moves.