What to Ignore (and Look for) During Earnings Season
Editor's note: Earnings season is underway – kicking off with 200 quarterly reports from publicly traded companies in the Russell 3000 this week. Investors, Wall Street analysts, and other market participants will be following the news in the weeks and months ahead to decide which stocks to buy... and which to sell.
That's why today, we're sharing a guest essay from Stansberry Venture Value editor Bryan Beach, adapted from the April 29, 2023 Masters Series. In it, Bryan explains what everyone gets wrong about earnings seasons and why it's important to look past all the noise...
Dear subscriber,
You may have noticed some odd price movement this week...
Online broker Charles Schwab (SCHW) surged 6% on Tuesday.
Streaming giant Netflix (NFLX) shot up 10% on Wednesday.
And aviation giant GE Aerospace (GE) increased 7% yesterday.
Collectively, the total market capitalization of these three businesses rose $56 billion in these single trading sessions. Netflix alone surged $35 billion... again, in a single trading session.
And if it seems odd that the market value of a business could be $35 billion higher on Wednesday than it was on Tuesday, well... you're right. That is odd.
So, what is the source of these market-rocking price moves?
It's the "earnings season" saga that plays out every three months. Between now and the end of March, publicly traded companies will release their quarterly reports, allowing investors and other market participants to glimpse the current financial health of their businesses.
This week, we saw reports from Netflix, Charles Schwab, GE, Capital One Financial (COF), Procter & Gamble (PG), and 195 other public companies in the Russell 3000 Index. And this is only the start...
The entire song and dance is largely a waste of everyone's time. But before we get into all the details, let's start at the top...
This whole charade began when investment banks decided to offer a service to large trading clients...
Decades ago, these banks started hiring analysts to cover large public companies. Over the years, the analysts' roles expanded. They eventually began publishing detailed reports... issuing buy, hold, and (on rare occasions) sell ratings... and even setting 12-month price targets for the stocks.
As a result, the CEOs of the public companies soon realized that they should cooperate with these Wall Street analysts... butter them up a bit. After all, these analysts had established relationships with big-money investors and worked for the same banks that would be able to raise money for their companies when needed.
So the CEOs and the Wall Street analysts started getting friendly with one another.
Every quarter, in conjunction with the quarterly "earnings release," company CEOs began hosting analyst calls which, actually, anyone can listen to. After the call, company brass speaks individually with the Wall Street analysts to discuss the business's forecasts and expectations.
There are often interesting nuggets of information dropped in these calls. In fact, I often listen in on companies that I follow. But, in general, everyday individual investors like us are not the ones benefiting from this game...
Over the decades, a ritual has developed out of this symbiotic little ecosystem...
As part of the back-and-forth relationship, companies provide "earnings guidance." That's just a fancy way of saying, "This is how much we'll probably make next quarter."
Of course, management providing information about the future isn't completely worthless. But some CEOs – like legendary investor and Berkshire Hathaway (BRK-B) founder Warren Buffett, for example – consider this whole process to be nonsense and refuse to play along. (By the way, if Buffett believes something is a stupid idea, you should pay attention.)
And the game doesn't stop there...
With management's earnings guidance in hand, the Wall Street analysts decide to make their own estimates. Eventually, media outlets and data aggregators begin consolidating the various analysts' estimates into a "consensus estimate"...
So during earnings season, these media outlets compare the actual reported results from companies with the consensus estimates. And then, they use dramatic headlines to report their findings to the investing public.
This rigmarole has evolved for decades. But things really kicked into high gear in the early 2000s, when the current financial-disclosure regulations came out and financial TV became ubiquitous...
Now, Yahoo Finance robo-journalists and TV networks like CNBC get free content for two straight weeks as they talk about which companies "beat" and "missed" analysts' estimates with the urgency once reserved for weathermen during hurricane season.
All of this noise builds up and leaves everyday investors with the false impression that something important just happened.
The thing is... almost nothing important happens with quarterly earnings.
Imagine asking your friend how her favorite football team's season went this year...
And she simply responds, "We were outscored 14-10 in the second quarter of the third game."
That would be worthless, right? You wouldn't know if the team had a winning record, if they made the playoffs, or if they finally beat their rival. In sports, quarterly results don't mean anything. It's about the entire season.
That's usually the case with the stock market as well. But we've somehow convinced ourselves that the financial world is different... and that it's big news when well-educated 20-somethings fail to accurately pinpoint the quarterly earnings of a global operation with tens of thousands of employees and a long-term strategy that could span a decade or more.
As we've seen, this song and dance can lead to a $35 billion surge in market value for a particularly big company.
Now, look, I'm not saying that Netflix was appropriately valued on Tuesday and suddenly overvalued on Wednesday.
In fact, the company released some very positive subscriber statistics on Tuesday. So the market's enthusiasm is understandable. Similarly, GE beat its analysts' profit estimates, as did Charles Schwab.
While this news isn't irrelevant, it's not earth-shattering either. To return to our football analogy... your friend's "Netflix" team outscored its opponents 20-0 this quarter.
Relevant data, yes... but it needs to be taken in the context of an entire season. And, with a public company's stock, an "entire season" can sometimes span an investor's lifetime.
Over months and quarters and years and decades, every company will have its stock-price jolts and mini-panics. And over the course of time, these moves – the big ones and the small ones – coalesce into a reasonable valuation of the business. But big one-day bumps and slides based on earnings releases are almost always overdone.
As of this week, earnings season is upon us. The media outlets and talking heads will be buzzing, as usual. But remember, it's mostly just noise.
What Our Experts Are Reading and Sharing...
A few weeks ago, I wrote to Stansberry Investor Suite subscribers about the "relentless bid" – a term that describes the collective market clout of 80 million passive 401(k) investors. As I explained, the relentless bid's constant stream of investment dollars into S&P 500 index funds is likely behind the soaring valuations of the market's biggest stocks.
Is this valuation bubble set to burst, like all bubbles eventually do? Or has the relentless bid fundamentally changed the way large-cap valuations work? These are fascinating questions – and only a few people are talking about it.
Back in August, financial pundit Barry Ritholtz interviewed Mike Green, one of the smartest investors and economists around... who also happens to have some strong opinions on the relentless bid. To listen to the interview – and learn more about this powerful force driving the markets – click here. (Note: The whole interview is great. But the discussion of passive investing and the relentless bid starts around the 21:30 mark.)
"The SEC Was Busy Last Week," reports Bloomberg Opinion columnist Matt Levine. Last Friday, with President Joe Biden officially heading out the White House door, the U.S. Securities and Exchange Commission ("SEC") filed a flurry of enforcement actions. Why would the SEC need to cram a bunch of new cases into the last week of a presidential term? And what kinds of actions did the SEC file? Find out here.
New Research in The Stansberry Investor Suite...
One of the tools employed by our analysts here at Stansberry Research is the Stansberry Score, which ranks nearly 5,000 publicly traded stocks each day.
The score assembles a host of quantitative metrics that measure things like earnings quality, profitability, business durability, and capital efficiency... into one simple number.
Investor Suite subscribers know that our team likes to highlight one highly ranked – or poorly ranked – company from the Stansberry Score universe every few weeks.
We've looked at companies like cigarette maker Altria (MO), casino operator Caesars Entertainment (CZR), and, most recently, global toolmaker Snap-on (SNA).
This month, we're doing a deep dive into one household name that has soared nearly 4,000% in the past 14 years thanks to... government cheese?
It sounds crazy, but it's true. In fact, you've almost certainly had this company's product at least once in your life.
Stansberry Investor Suite subscribers can read the entire report here.
If you don't already subscribe to The Stansberry Investor Suite – and want to learn more about our special package of research – click here.
Good investing,
Bryan Beach
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