Three Rules For Earnings Season


Today, after the market closes we will see what many regard as the start of earnings season; Alcoa (AA) will release their Q1 2014 earnings report. AA has long been regarded as a bellwether stock, giving early indications of the health of the economy as a whole. In today’s tech heavy world the performance of an aluminum company may seem a little less significant, but I suspect that we will, if nothing else, begin a recurring theme today that is very dear to my heart as an Englishman: there will be a lot of discussion of the weather.

These weather issues will no doubt complicate the interpretation of revenue and earnings numbers for the last quarter throughout the season. There will undoubtedly be cases in which the snowstorms of January and February really do make a material, albeit temporary, difference to the top line, but there will probably be more where CEOs and CFOs use it as an excuse for any poor performance or perceived weakness.

For individual traders and investors this is likely to be a trying time as they attempt to sort the truth from the excuse. Even if they have a finely-tuned excuse detector and mange to do so, they still have to consider the possible effects of last quarter’s performance when taken as a whole, and what it means for Fed policy.

Consensus is now that QE has been successful, at least in market terms. It’s hard to argue otherwise when the S&P 500 has more than doubled since the Fed began expanding its balance sheet, but the distortion of the market that this has caused results in more uncertainty than ever. Every piece of news has to be considered, not just in and of itself, but also in terms of its likely impact on easy money. Good news can quickly become bad if it hastens the exit from QE or the return to normalized interest rates.

It looks, then, as if this may be a confusing and complex earnings season. Complexity is nothing new in financial markets and I am always a little suspicious of commentators who attempt to prevent things as overly simple. If it were always straightforward traders wouldn’t be paid the big bucks and we would all make the right decision all of the time, but they do and we don’t. That said, while I don’t deny the complexity, there are a few basic rules that an individual can follow at times like this that will give you a decent chance of making more good decisions than bad.

  1. Don't Read Too Much Into One Result: This is not a quarter to be reaching broad conclusions from any one company’s performance. Just because one company in a sector or industry has a disappointing quarter doesn’t mean that the same will apply across the board. Although it is likely that all of those reporting will cite the weather factor it will impact each individual company’s performance differently and the implications for the big picture will be muted. The Fed will not look at individual results, but rather any distinct trend that may emerge and you would do well to do the same. Similarly, even if results are a bit disappointing for a company that you like you may have to ride out some short term volatility if the basic case for your enthusiasm remains intact. Don’t make any hasty decisions.
  2. Trade The Reaction, Not The News: Accept the fact that as an individual trader or investor you aren’t going to beat the floor traders and computers in reacting to any announcement. Let the initial response happen and then assess the situation. How the market responds to news often tells us more about what is coming than the news itself. If traders look only for signs of weakness then we are in for a rough couple of weeks, but if good news is being ignored, then there will be plenty of opportunity for both long and short term investment in stocks that come under pressure.
  3. Watch Capital Expenditure: Over the last few years the market has done fine but it has been hard to get massively enthusiastic for an economy that has been grinding along at around 2.5% growth and still has above average unemployment. If things really are improving and demand is truly picking up then companies will begin to spend some of the cash that they have been holding to meet that increasing demand. If, on the other hand, there is evidence that firms are looking to add to the bottom line by squeezing even more cost savings out of their business then my overall bullish stance will be moderated somewhat and looking to take some profit from stocks that react positively to this round of numbers will be a prudent course of action.

Really, what it all comes down to is “Wait and see.” If you are reading these pages then you are probably somebody who takes an active interest in their investments. One of the biggest mistakes that those of us who do that make is to react to everything we hear. The next few weeks will see a ton of information surface, but not all of it will be reliable as a long term indicator. By looking at overall trends rather than individual performances, waiting for the market to react before acting yourself and keeping a wary eye on capital expenditure you should be able to survive and even prosper over time.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , Investing Ideas , Earnings , Stocks

Referenced Stocks: AA

Martin Tillier

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