The Truth about Earnings Season – Expectations vs Reality
Earnings season on the ASX is in full swing. We are one month in and company reports are flooding in. It’s now the beginning of March and we can truly say we are half-way there.
There is an obligation for ASX listed companies to report their financial results to shareholders that occurs at least twice a year. Depending on the companies reporting calendar, it may be their half-year result or full year report.
Most companies file quarterly statements which provide brief content throughout the year. While insightful, quarterly statements don’t paint a full picture. As they often only highlight the position of cash flow.
The main reports are typically the half-yearly and full year reports. These are the two reports investors pay more attention to and scrutinize over.
If you thought high-school public speaking was tough, investors can rip apart companies if the reports don’t meet expectations.
In all honesty we should call Earnings season, Expectations season.
Expectations from Earnings Season
It is the job of financial analysts to forecast company earnings, cash flows, growth and so on. You can subscribe to many paid services that gives you insight into all these information.
Forecasting is an imperfect and often impossible task. If the future was knowable, everybody will know what to do and the opportunity of making large sums of money disappears.
While there is an improbable chance forecasting will be accurate, it is necessary for valuing a business. This forecast is what many investors anchor to when earnings report comes out.
There are many different types of businesses on the ASX. They range from mining all the way to consumer discretionary and all the way to large banks.
What they all have in common is their ability to generate returns for shareholders. There are many variations to what you should look out for. Generally if a company is moving in the right direction, like a staircase going from bottom left to top right. It is a good sign.
So if revenues and profits are up, that’s good. If revenues are down and profits are down, thats bad. But only if it were that easy.
The Reality of Earnings Season
The reality about earnings season is that share prices don’t usually follow earnings results. You might have re-read that sentence twice. But no, I wrote correctly.
Earnings season should be called expectation season. Why?
There are many different types of “investors” in the stock market, notice the “”. That’s because while there are many who invest for the long-term future growth of a business.
There are many other forms of market participants. They may be looking for a quick buck like day traders, or they may be large institutional investors. And then there’s the herd that follows the crowd.
Regardless of who they might be, these market participants have preconceived results they are expecting. In most instances, share prices will move in the direction you expect.
So why do stock prices sometimes experience a fall after positive results were announced. Or go up higher after bad results?
That is because investors expected results to be better, or they expected results to be worse.
It is the majority that decides the price of the business on that particular day. So it is important for you to know what you yourself are expecting.
Know your Own Earnings Expectations
Valuing a business is very personal. Two investors with the same set of data, will almost be guaranteed to have differing share price fair value. It depends on the growth rates you expect, your required rate of return, etc. the list goes on.
To help you understand, there is a quote by Benjamin Graham where he explains that “in the short run, the market is a voting machine but in the long run, it is a weighing machine“.
In the beginning, thousands of market participants will be in a price war to see who is right. This explains the volatility you see in the market.
But over the long run a businesses performance will reflect its underlying value. With so many differing opinions on the fair value of a business, who is right?
You cannot be sure as to who is correct, but you as an individual investor can make a best guess assumption. That way you are relying on your own thesis, projections and forecasts.
As long as you have a general idea of what to expect in a company you invest in, you do not have to worry about what the share price does. Know what you buy and why you own it.
If you like the results, and the share price drops. That’s a buying opportunity. If you hate the results, and the share price rises. That’s a selling opportunity. But in many instances, the best course of action may just be to do nothing.
Key Takeaways
- Earnings season is best described as expectation season
- The reality is, share price does not always go the direction you expect it to
- Know what you buy and why you own it
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