Value investor with a deep passion for understanding and a desire to improve results over time.
Making Sense of Investing
During earnings season, the companies you're following are reporting left and right. Sometimes a company will report a huge earnings beat, but then their stock will go down, and sometimes it can be tough to make sense of what really matters to an investor. Let's make sense of all the chaos.
What Numbers Are They Beating?
Every quarter, most publicly traded companies are covered by a number of analysts. These analysts follow the stock's underlying business by studying the fundamentals, and they make determinations on how the company will do in the future.
In addition, some companies offer guidance for the future, giving the investing public their best guess at how their performance will be in the next quarter or year. Company guidance can often be an incredibly useful metric for analysts to use as a north star, anchoring their expectations for how the company will do around a number the company itself puts out there.
You've probably heard the phrase, "it all comes down to earnings!" This is at least partially true, given that the value of an investment, according to value investors, is the expected future cash flows, discounted back to what money is worth today.
Cash flow and earnings aren't always closely correlated, but Wall Street generally only has the patience for one or the other, and they're generally always going to report "earnings" as the main metric.
When a company misses on earnings, that just means it's falling short of what analysts thought the company would do for this quarter. Since the market has priced in another story, one based on the expected earnings that haven't actually materialized during the last three months, some repricing is due. That means the company's price is likely to decline, often in proportion to the miss in earnings (or cash flow).
Sometimes, a company will miss on earnings, but the stock will still go up. If that's the case, it's very likely that they beat on revenue. While profit (earnings) is what's left over after the company has spent everything it needs to spend to run the business, revenue is every dollar that comes into the company at the very top line.
If a company is growing quickly but is not yet profitable, investors will often forgive earnings misses, provided the revenue is still beating expectations. This might mean analysts are expecting a loss, and the company's losses came in even worse than expected, but their revenue went up more than expected.
Most of the time, though, if a company misses on either revenue or on earnings, the stock price is going to go down the week of the earnings release.
There's one more equally important idea we need to consider: company guidance. This is what the company itself tells investors it's going to earn and rake in over the next quarter.
If a company gives consistently good guidance, meaning they often predict closely what their earnings and revenue will be, then analysts are likely to have more accurate predictions.
You can often find predictable, boring investments by looking at a long history of accurate guidance, coupled with beating expectations slightly on revenue and earnings. That's like a magic formula for a stock on Wall Street, and many companies specifically try to play this game.
In the realm of guidance, a company will also offer some idea of how they're doing internally, outside of financial statements. This might mean tracking a KPI (Key Performance Indicator) that determines how successful the business should be in the future, like subscribers to a service that just signed on or the numbers of future drugs currently in various different stages of development for a pharmaceutical company.
No matter what sort of company, there's always a need to understand where the future cash flows are going to come from, and this pipeline is all-important. If you're looking at a Bitcoin miner, you should probably understand how heavily correlated that company is to the price of Bitcoin; if you're looking for something that may be adopted at some point in the future, you need to consider how far off widespread adoption might be, and so on.
Good companies tend to offer a window into the most important metrics to follow, and whether the company has beaten or missed its own internal expectations for whatever these numbers are. They're saying, "If we beat these numbers, we'll make lots of money in the future, and so will you." It's your job as an investor to make sure they actually beat those numbers.
Factors That Affect Stock Prices
- What Affects a Stock's Price?
Stocks go up and down, sometimes seemingly for no reason at all. Why do they behave the way they do? Here's some insight.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2022 Andrew Smith