First, earnings, of course. They're announced every quarter and summed up at the end of the fiscal year. We're starting the first quarter of most companies' earnings now. Alcoa reported on Monday. But there's much more to an earnings report than just the earnings number, a number that reflects the profit or loss for the previous three months.
-Management's Forecast. This may be even more important than the numbers. Most CEO's will give an appraisal of where the see their markets and businesses headed. If they revise their earlier estimates for revenues and profits downward, the stock will immediately reflect that. If it's upward, investors like that and will usually bid up the stock. The latest example of that is Alcoa. It reported a small loss (3 cents a share). It was mostly expected. But revenues were better than anticipated (see below) and management was optimistic about 2012. The stock rallied on the news in spite of the loss in earnings.
- Revenues. While earnings are the driver for stocks, what is almost as important for investors is revenues. They will be going up or down. Good stocks always have a way of seeing revenues increase. Again, Alcoa is a good example. It showed sales of $5..99 billion for the quarter, well above the $5.7 billion analysts predicted and a solid increase over the $5.65 billion of sales in 2010's last quarter. It's the eighth consecutive quarter of year over year revenue increases. When revenues continually improve, earnings usually follow.
- Extraordinary events. As indicated, these don't happen every quarter like other expenses. They're extraordinary. That means if a company has an unusual occurrence, such as a tornado knocked out a plant, it's not likely it will happen again. Most analysts overlook these events and factor back into their calculations the earnings that the event damaged. However, some companies have a way of experiencing extraordinary events every quarter. This should raise a red flag for investors, especially if those events are made internally, such as accounting adjustments, the worst kind. Most often, accounting adjustments are like cockroaches. There's never just one.
Extraordinary events will hurt headline earnings. Earnings are reported as a single number. But it's important to look behind the headlines to see what makes up that number. Sometimes extraordinary events, like the sale of a division, will greatly enhance earnings. That, too, is a one time thing and shouldn't be included in any ongoing earnings calculations or estimates. Watch out for extraordinary events, good or bad, happening so often that they become ordinary. It means the company isn't being managed well or is enhancing earnings in ways that aren't sustainable.
- Expenses. Are they growing? That can be good. Growing companies need to add new people to satisfy orders or increase service. The real question is: are they growing, as a percentage, faster than revenues and profits? It's only when expenses get ahead of a firm's internal growth that some concern can be raised. Sometimes a company will staff up a new department in order to develop a new product or service. That will make expenses rise without a concurrent increase in revenues or profits. But if the department delivers, that expense will become a smaller percent of revenues and profits. It's the trend that investors need to follow. Any time expenses continually rise faster than the income side of the business, it's a problem that shows up in profits.
There will be thousands of companies reporting earnings over the next several weeks. With these particular elements in mind, read them more thoroughly than just the headlines. The headlines (and just earnings) don't begin to tell the story of what's going in a company.
- Ted Allrich
January 10, 2012