Brief guide for the upcoming earnings season

The third quarter officially ended September 30th, meaning that earnings season is about to kick off in full stride.  Earnings season is when companies report their financial performance for the quarter just ended and the year-to-date, as well as provide guidance for upcoming quarters and next year.

You might expect then that earnings season is highly anticipated and celebrated.  To the contrary, earnings season is that time dreaded by all analysts and portfolio managers as their days become filled with boring-assed conference call after boring-assed conference call.  Typically earnings season can be compared with combat.  Extended moments of unbelievable boredom punctuated with rare moments of sheer terror.  So it might be helpful to have a little bit of an idea as to what to expect and to pay attention during this time.

Things to watch:

1. Growth opportunities.  Companies usually begin strategic planning for the upcoming year about now.  Therefore, many businesses will be talking about their growth opportunities.  And here, I mean revenue growth.  Sales have been flat to only slightly up for almost all U.S. businesses for a year and a half.  Almost all of the record profit growth has been coming from expense savings wrought from squeezing suppliers, real estate owners, and by firing employees.  Sectors to watch for growth opportunities are:
   • Technology.  Here I am talking about the likes of Apple, Sony, Hewlett-Packard, Dell, Intel and Microsoft.  While there are many thousands of technology companies, these are all bellwethers whose growth presages economic health or catastrophe.  It will be interesting to see from where new sales are coming.  From the U.S. or overseas?  From consumers or businesses?  From new sources or old?  Prediction: Business orders will lead the way with only slight increases in purchases on the part of consumers.
   • Retail.  I have almost never been an investor in retail businesses.  It all boils down to one word: fierce competition.  Okay, that’s two words, but you get the point.  No retailer has a monopoly on its goods as substitutes abound.  But the reason I am saying to pay attention to retailers is because consumers are the customers of retail businesses.  So revenue and profit reports from retailers will be an indication as to the mind of the consumer.  What will be important to pay attention to is what sorts of discounts retailers are having to offer in order to induce that marginal dollar consumer spend.  Prediction: It is my feeling that consumers are still not opening their wallets.  Therefore, growth opportunities are likely to be tepid for retailers and won after offering severely reduced prices.
   • Construction.  We all know that the Great Recession was precipitated by an overheated real estate market (thanks Federal Reserve).  But construction still is gasping for air as it struggles to shore up its finances, work through excess real estate inventory, and to find ways to induce the purchase of new properties.  Ugh!  If construction, both commercial and residential, is recovering and seeing growth of its topline then it will be a strong indication that the economy is stable through and through.  Prediction: Construction will continue to lag the overall economy.  I expect there to be flat to only slightly up revenue growth from this sector.
   • Financial institutions.  For the same reasons stated above in construction, banking institutions have remained mired.  Yes, they have reported record profits for the last year, however those profits are coming from places like investment banking.  What I would like to see are growth opportunities sown from new mortgages and from consumer deposits.  Prediction: The financial institutions will post very robust profits as market trading has been fast and furious.  However, the back bone of all financial businesses are retail deposits.
2. Jobs.  If growth opportunities are improving it will mean that either existing workers are going to be stretched more thinly or that businesses are finally going to have to hire new employees.  Typically new hiring is not announced during earnings season.  But it can be inferred from discussions of candy mountain-like revenue growth.
3. Weak spots.  It is no secret that the worldwide economy is still very, very hung over from the Great Recession (nè the Great Debt Punch Bowl).  There remain many weak spots in the economy and those businesses are hampering the recovery.  I will be tracking, and you should track as well, those economic sectors that universally report having problems.  From that information much about the economy can be inferred.  Additionally, the natural cause and effect outcome from these weak sectors can be assumed, too.
4. Surprises.  Most earnings seasons are punctuated by surprises.  That is, businesses that either over or underperform relative to expecations.  What is interesting is the general tenor.  Are the majority of reporting companies surprising on the upside, or the downside?  What is the financial market response to these surprises?  If the markets “vote” in alignment with the surprises then it means that most market participants were genuinely surprised.  That means that as an investor there is a real opportunity to make money.  Either you are already invested (remember my admonitions for the past six months) and will benefit from a rise, or you have avoided some of the business sectors I have lambasted and you will avoid a declining market.  If, on the other hand, the financial market response is tepid, then it is a sign that investors have been expecting such results.  Prediction: Most businesses are likely to report stronger results and I don’t feel that most investors have factored this into their calculations.  Thus, I think that we are likely to see a stock market performance that is robust.  If the lift in share prices is high enough then the retail investor (that is, the little guy or gal) is likely to start deploying some of the cash that has sat on the sidelines for the last couple of years.
5. Elections.  The mid-term elections are less than a month away and it is very likely that the Republicans and Tea Partiers are likely to end Democratic dominance of Congress.  Like it or not, investors typically prefer Republicans to Democrats and so the financial markets are likely to cheer such a result.  I am no political prognosticator so will not make any predictions as to what the non-Democrat controlled Congress will do with its power.  However, I will closely watch any policy rumblings coming out of Washington and do my best to assess the likely affect on your portfolio.

In conclusion, I intuit a strong earnings season with better than expected revenue growth.  That will lead to profits/earnings beating expectations and to a surprising degree.  That, in turn, will lead to a robust stock market performance that will likely lead to market prices being higher at the end of the November (roughly the end of earnings season) than they are now.

Jason