Everyone focuses on the performance of stocks that met or exceeded earnings estimates, but few focus on what happens to stocks after they missed earnings “estimates” last quarter. The later tells you the real mood of the market. If stocks that recently missed their estimates move above levels at which they were when the earnings were announced then one must ask – if a negative earnings surprise could not hold the stock down what will?
This is going to be a big week in terms of earnings announcements with profit reports from 146 of the S&P 500 stocks (29% of the index). Approximately 37% of S&P 500 stocks have already reported and the results have generally been better than expected, with earnings growth outpacing revenue growth. So far 77% of the companies that have reported results have beat expectations. This reflects how overly pessimistic analysts have been.
CNN quotes the following regarding the earnings announcements:
“That 77% figure will likely come down a bit by the time all the results are in, said John Butters, senior research analyst at Thompson Reuters. But if that number holds up, the second quarter will mark the highest percentage of upside surprises since Thompson began tracking results in 1998. It’s really been companies across the board beating, with most sectors running higher, Butters said. But the caveat is we have more than 60% of the S&P 500 stocks to go, so the results will probably change”.
We find the last sentence rather interesting. Surely a sample size of 37% is large enough to conclude that the results won’t change for the remaining 63% of companies due to report, i.e. there is unlikely to be a significant change in the percentage of companies that have beat estimates (the 77% figure). There has also been substantial commentary regarding the “quality” of earnings. Commentators note that it is only really cost cutting efforts that have resulted in better than expected earnings.
We believe that the comments above typify the mood of the market right now. There seems to be too many commentators who are not willing to believe in the rally or the fundamental underpinnings of it. Commentators also lose sight of what drives stock prices in the first place. A stock price is the price of a given level of earnings in the future (albeit the lack thereof as sometimes is the case). Accordingly one must not ask the question: “what is the earnings going to be” but rather “what level of earnings is already factored into the stock price”
No matter how good the earnings of a company are, if they come in below expectations then there is a high probability that the stock price will fall. Yes this may seem rather simple stuff but this relationship (earnings vs. expectations) is more often than not overlooked.
Accordingly we are not interested in earnings, no matter how “bad” or how “good” they may appear, we are interested only in how the market reacts to the earnings reports. So far at least the stock market, given the way it is reacting to earnings reports, seems underpriced. Of course it will be interesting to see how Microsoft and Amazon perform over the coming days having missed estimates last week. If they move to multi-week highs over the coming days that will give a very powerful buy signal.
Our global wealth builder portfolio (Earnslaw), which consists of only 12 ETFs and is the vehicle in which we manage our retirement funds, is up 27% since the start of the year. Subscribers are privy to the holdings, weightings and trades prior to use executing them.
