Three Quarterly Market “Tells” You Need to See (and What They Say Now)

Keith Fitz-Gerald Feb 06, 2015
24 

What I am about to share with you today won’t win me any friends on Wall Street. But, that’s how it goes.

This is important information to you as an investor and that’s why you need to know what it’s telling you. So I’m happy to take my lumps and show it to you anyway…

Right now we’re in the midst of the first “earnings season” in 2015, with publicly traded companies reporting their latest quarterly results – in this case from Q4/2014.

Millions of investors are understandably anxious and confused. Companies take off like a rocket on good numbers or get a multi-billion-dollar haircut on bad ones.

Thing is… Wall Street likes it that way. The more confused you are, the more profitable they are because investors who chase innuendo tend to trade more (and generate bigger commissions).

That said, it’s NOT a waste of time if you know how to sort out the information that actually matters and what it says about your money.

Here’s what you need to know.

Why Earnings Reports Are Overrated

Earnings season is a lot like going to the circus… a whole lot of “oohing and aahing,” bright lights, and noise. It’s entertaining but next to irrelevant for anyone interested in building real wealth over the longer term.

First, there’s a tremendous mismatch between the business cycles of most publicly traded companies and the quarterly reporting system. So the information being presented really doesn’t give you anything more than a snapshot of a company’s performance – and a badly focused one at that.

Take Boeing, for instance. The company has a multi-year lead time on any aircraft or weapons system order. So the notion that they’ve got to report numbers every 90 days is fundamentally flawed, especially when you’re talking about billion-dollar sales cycles.

Or how about Alibaba? The company has terrific numbers and unprecedented growth that it will capitalize on for years to come. Yet the street gave it an 8.8% haircut after gross profit margins fell to only 71.3%. Yet, the same market pushed Amazon shares up 8% after the closing bell with a comparable gross margin of 22.77% and a quarterly profit margin of 0.73%? Gimme a break!

Second, investing based on earnings expectations is like betting on a horse race after you know the results. That’s because most public companies provide guidance which is, of course, duly managed by competent CFOs to ensure the numbers are hit. Right now the forward-looking numbers have been guided steadily downward for several years, making any “beat” suspect. But the markets fall for it anyway.

Third, analysts are terrible stock pickers, generally speaking. Their job is to analyze data, gain insight, and assess value. Not trade. Institutional managers, on the other hand, are tasked with making money. There’s a big difference.

You can see that very clearly in a survey back in 2006 by Institutional Investor magazine, the most prominent professional publication of its kind, which actually showed that stock selection was ranked 11th out of 12 possible criteria prioritizing analyst capabilities.

That was made pretty clear in two of the biggest stock market routs in recent history, the Dot.bomb crash and the 43% fall from July 2008 to March 2009 that catapulted the world into the ongoing Financial Crisis. 10 months into the tech meltdown in 2001, for instance, Solomon Smith Barney analysts tracked almost 1,200 stocks. Yet, the firm had no “sell” ratings and only one “underperform” on the books. Is it any wonder the public is annoyed?

This era of careless optimism with other people’s money is changing, of course, but upside bias is still a tremendous problem on Wall Street because of the incestuous relationship between investment bankers, analysts, and brokerage houses.

Fourth, analysts are compensated for clout, knowledge, and data. Accuracy isn’t part of the equation. Given that some analysts make millions a year, I’ve got a problem with just how subjective most of Wall Street’s research really is, especially when huge conflicts of interest are normal operating procedure. Chances are you do too, or you wouldn’t be here.

But again, there is ONE thing you can learn from earnings season – the bigger picture still matters.

We’ve talked about this a lot because it’s where the notion of a globally unstoppable trend comes from. Why track a stock or two worth a few hundred million when trillions are on the move? To me this is a lot like trying to fight an individual wave at the beach when the tide’s changing – not very productive.

Here’s how you sort things out:

Earnings Season “Tell” No. 1:

The overall earnings scorecard is most important for the present

The number you’re looking for to put earnings into the bigger context is the aggregate percentage of companies reporting that have turned in earnings and sales numbers above mean estimates. Β Earnings will tell you what’s going to the bottom line (so named because they are typically found at the bottom of a company’s income statement), while sales numbers clearly highlight the top line, or gross sales revenue.

As of January 30, for example, there were 227 companies that had reported Q4/2014 data. Approximately 80% reflected earnings above mean estimates, and 58% turned in sales above the mean estimates.

What this tells you is that, generally speaking, things are still pretty good in corporate America. As low as the earnings are and as suspect as the numbers remain, there’s still plenty of money moving through the system.

You can also learn a lot from the balance between the figures. For example, here we’re talking about 80% versus 58%. This ~20% gap between the number of companies beating earnings estimates and companies beating sales estimates tells me most companies are still benefiting from increasing efficiency rather than raw top-line growth. It also suggests that the recovery really isn’t what politicians think it is. Real growth typically reflects a more even distribution.

It’s important to note that this number changes almost daily as more companies report. So you don’t want to get hung up on the initial picture. The earnings scorecard actually gets more accurate as earnings season progresses and more companies report.

Earnings Season “Tell” No. 2:

The estimated earnings growth rate is your guide to the future

When a company reports earnings, it typically also gives a projected year-over-year earnings growth rate that can be used to compare anticipated future performance with where a company stands today.

Again, I’m not so concerned with the individual results here, but the aggregate.

Right now, for example, the blended estimated earnings rate approximately halfway through earnings season is a mere 2.1%. That’s the eighth consecutive quarter of decline, and down significantly from the 9.9% that was expected last autumn on September 30, according to FactSet.

You don’t have to be a rocket scientist to see where this is going – straight into negative territory.

There are a couple of key takeaways here, just like there were for the earnings scorecard, not the least of which is that 2016 may be a dicey year for markets. So you’ll want to begin preparing now by limiting new money to only the highest quality stocks with rock-solid balance sheets, tons of free cash flow, and expanding margins that are aligned with our Unstoppable Trends – the stuff we talk about all the time.

Of course, the slide also suggests that you’ll want to think about harvesting profits using trailing stops or profit targets, too. But not for reasons most people think.

Raising cash is not merely going to the sidelines to get out of the way. No, it’s about taking steps that ensure you’ll be flush with cash when stocks are “on sale.”

Buy low and sell high… that’s how the game works.

Earnings Season “Tell” No. 3:

Group things into what’s moving and what’s not

Many investors get wrapped up in the minutia associated with individual companies and wind up playing a magnificent game of “coulda, woulda, shoulda.” Let’em.

Instead, take a more detached look at what’s working and what isn’t. That way you can make any portfolio adjustments needed to rebalance or even add to existing positions.

For example, this earnings season has been a tale of two markets so far. Anything with a strong domestic footing has done well while companies with huge dollar exposure and inadequate hedging abroad are underperforming. McDonald’s is a classic example, as is Microsoft.

Generally speaking, one quarter’s trash is another’s cash, so you want to buy into the fray, especially when the fundamental business case driving a company you’re considering remains intact. That’s the case for many energy and defense stocks at present.

In closing, I’ve obviously just scratched the surface. There are literally thousands of data points you can consider depending on how complicated you want to get.

But I think earnings season is one of those cases where simple really is best.

Until next time,

Keith

24 Responses to Three Quarterly Market “Tells” You Need to See (and What They Say Now)

  1. Sailor Jo says:

    Very good reminder that one has to make sure not to miss the forest for the trees.
    During the dot-com bubble I learned that analyst’s musings are just that. Fuggetaboutthem.
    Also, I despise the constant barrage of “data” that have no meaning by themselves and just give some individuals the time in the media. Why are housing data split into 20 categories and each is announced separately and then I have to collect the data to get a picture? Not efficient nor helpful.

    • Keith says:

      Thanks Jo!

      We humans are a strange bunch. In as much as we love the big picture, science has demonstrated that we all tend to focus on the minutia when emotions run high (which is, of course, why the first thing we want to do is get emotion out of the equation). That’s where the expression “tunnel vision” comes from as you likely know.

      Best regards and thanks for being part of the Total Wealth Family, Keith πŸ™‚

      • tom breznau says:

        Keith,

        I enjoy and profit from your articles a lot. Like John, below, I too am using option positions to reduce risk (some 2 or 3 sided positions) and keep a lot of cash. Rather than shorting I bought some Blackberry puts a week ago in response to your short rec!

        Thanks

  2. Martin Cohen says:

    Keith, Take a look at Biolase Technology (BIOL), the world’s leading manufacturer of dental lasers. A biotech private equity firm infused roughly $18 million in the company to support product development and international expansion. The dental laser market has captured only 5% of the dental market, but because of improved productivity is moving into being a generally accepted technology. The major kicker in the growth of the company is that the FDA recently approved their laser technology for use in many other medical markets, opthamology, dermotology, general surgery, pain management, veterinary, etc. The old high in the stock exceeded $20 at an earlier stage of development. The company is exiting a turnaround phase and has been base building in the $2 to $3 price range for about a year. There is substantial institutional following of the company and with prospect for improved revenue and earnings ahead a high probability of a breakout.

    • Keith says:

      Thanks Jim.

      I’ll take a look. Sounds intriguing. Thanks for the heads up and have a fabulous weekend.

      Best regards and thanks for being part of the Total Wealth Family, Keith πŸ™‚

  3. Jim Eddins says:

    Keith:

    This is the best explanation of earnings season I have read. It brings into perspective what forward looking statements are and what they are actually covering up or protecting as each position demands.

    • Keith says:

      Hello Jim.

      Thanks for the kind words; I’m glad this helps!

      Best regards and thanks for being part of the Total Wealth Family, Keith πŸ™‚

  4. John Lakeman says:

    Hi Keith, As a subscriber to the geiger index, I have found a unique way of making money on options. Never knew anything like that before but as a member, I found that it is easier to make the money through options than outright buying the stock. I appreciate all the effort you do for your members.
    I recently sold short TWTR, from an article you published recently about the stocks not to buy, etc. I did sell twtr but it seems that it jumped to record proportions. Do you think this is short termed?

    • Keith says:

      You made my day John! Thanks for sharing and for your perspective. To be honest, when I developed the Geiger, I knew it would be great, but I had no idea just how how great nor how many people would love it. More than a 100 trades later and with profitability pushing levels most investors have never imagined, it’s been a fantastic journey.

      As for Twitter, the social media meme is very powerful at the moment. And, that means the markets can be illogical. This stock is a classic example of “hope” pushing prices higher because every metric available suggests it’s a dog longer term. The key is to manage your stops appropriately. Even the best traders sometimes take 3, 4 even 5 swings at a stock before it ultimately crashes. That was the case for many with Blackberry and even Radio Shack. So, yes…definitely short term.

      All the best regards and thanks for being part of the Total Wealth Family, Keith πŸ™‚

  5. Jim says:

    Very sensible and useful talk….as much as it is easy to forget.

  6. Sheila Scott says:

    Hi Keith: Have followed you for a long time and enjoy your articles. With the Canadian dollar devalued at least 20% at the moment, do you have any suggestions for TSE entry points? Keeping cash at the moment to see
    which way dollar goes. As goes oil, so goes Canadian dollar.

    Thanks

    • Keith says:

      Hello Sheila.

      Thanks so much for the kind words and for your confidence in me.

      The dollar is definitely knocking things for a loop and, because we have so many Canadian subscribers like yourself on board, I’m looking very carefully at ways we can tap into the Toronto Stock Exchange, too.

      Stay tuned!

      Best regards and thanks for being part of the Total Wealth Family, Keith πŸ™‚

  7. robert weick says:

    ekso looks like the one to own it has 150pat, in 2yrs went from 0 to 100 this is basted on earnings est earnigs is bas

    • Keith says:

      Thanks Robert. I think so, too. It’s one of those companies with the potential to refine the future and the industry it served over time. Obviously, it’s still early days so volatility is to be expected, but that’s where the biggest returns often come from.

      Best regards and thanks for being part of the Total Wealth Family, Keith πŸ™‚

  8. bernie says:

    Now you have all this data how come we do not play the news on good earnings before it gets to the street ?Hows got that TAX DATA ? a+b=

    • Keith says:

      Thanks for asking Bernie.

      I think that’s a very logical question. Unfortunately, the bias is firmly with insiders who are privy to this stuff before it hits. So, if you are to play ahead of time, you are put in the unenviable position of a) having to second guess them when material insider trading reports are not filed by the SEC until after the fact and b) you’ve got to hope they’re right. In plenty of instances, they’re not. That’s why as tempted as it is, the bigger picture remains important.

      Best regards and thanks for being part of the Total Wealth Family, Keith πŸ™‚

  9. Steve says:

    Dear Keith,
    So enjoy your expertise. You have and make good sense to me.
    I have 1,000,000. Coming in at once this month. With the market towards its highs. Was wondering how you would deploy this. Dollar cost average? If so, in what and a time frame.. Appreciate your thoughts. Steve

    • Keith says:

      Thanks for the kind words Steve and for being part of the Total Wealth Family.

      First, congrats. That’s a hefty sum of money. And, second, that’s a great question.

      As you know, I cannot offer individualized investment advice, but I would like to tackle your question in an upcoming column. Whether it’s $1, $1 million or even $100 million, the principles are the same. And very relevant at the moment for the reasons you’ve identified.

      Best regards, Keith πŸ™‚

  10. Dennis Pollack says:

    Hey Keith,
    Greenspan is telling us to “buy gold”. Yellen is saying “be patient”.
    I guess you could say that “politics makes strange Fed Fellows”

  11. Pham Diesel says:

    For the foreseeable future, more and more capital expenditure is moving into onshore β€œtight” energy plays and offshore opportunities. These are long-term investment trends in which the funds are dedicated, the contracts are signed and the barrels are coming. We’ll see more and more wells, onshore and offshore, with more and more capex flowing to the service and equipment providers. i should go where the money is flowing, and that happens to be the energy world for now. I can feeling but I still … I do more good but what can I do for more good ?Diesel Pham.

  12. robert weick says:

    I am new at this, it sounds interesting.i would like to get stared.

  13. THOMAS GENE KESTER says:

    KEITH, 2/12/20

    YOUR MONEY MAP REPORT SHOWS INVESTING CAN BE AS ATTRACTIVE AS TRADING.

    AND, YOUR OBSERVATIONS ABOVE COULD BE SAID ABOUT DAYTRADING.

    GENE KESTER

  14. RJ says:

    A well-written and cogent case for not chasing the point-of-fact numbers and instead taking a macroeconomic perspective.

    Thank you for pointing out that the dotcom bubble was the precursor to the 2008 fiscal calamity (and thank you Alan Greenspan). This is a whole other area for discussion, but let’s move on.

    Your point about skewed stock valuation in light of earnings is excellent. For example, Amazon shares rising and Alibaba shares falling. I have wondered for some time how Amazon’s media marketplace survives. Sure, the prices are exceptional. But are they making a real profit here, as opposed to other divisions of this company, such as their contracted e-commerce engines and cloud web hosting?

    Lastly, I have a basic question: can you give me sources that I can use to find the institutional exposure to certain stocks and companies.

    Thank you.

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