Corporate Earnings: Is Their Weight Worth the Wait?

If you follow the stock market, you see news reports about corporations’ earnings results and expectations. And you may have noticed that not meeting expectations can cause a corporation’s stock price to tumble.

This harsh punishment illustrates how closely investors monitor corporate earnings and the role of financial analysts’ expectations in driving stock prices. Often, investors view a company’s profits — or losses — as a key indicator of its financial health and future prospects.

Analysis and Forecasts
Because of this strong interest in corporate earnings, financial institutions employ analysts who monitor and forecast the earnings of publicly traded companies. Forecasts require research — meeting with company management, evaluating the competition, conversing with suppliers and customers. Based on that research, analysts write reports that include estimates of how much they expect companies to earn in subsequent quarters.

When a publicly traded company announces earnings, many investors compare the financial results with the analysts’ prior estimates. Companies are said to “meet,” “exceed,” or “miss,” estimates.

Expectations Versus Results
If a public company’s earnings miss estimates by only one or two pennies, investors may interpret this as a negative sign and sell the stock, even if the company remains profitable. Conversely, if a company’s earnings exceed estimates, many investors see this as a positive and buy more shares, driving the stock price up further.

This scenario illustrates how analysts’ actions regarding short-term financial results can influence stock prices. Many experts agree that it’s rarely possible for a company to deliver escalating earnings quarter after quarter.

Yet some investors fear that if a company doesn’t “beat the street,” the stock will nosedive and they will lose money. That’s why certain short-term investors quickly sell stocks that don’t meet or exceed financial analysts’ estimates.

Short-Sighted Selling
While many shareholders trade stocks periodically to rebalance their portfolios, significant trading generates costs that can dampen returns. A high level of stock trading also signals a desire to “time the market” which typically generates investment losses.
Even experienced professionals have difficulty knowing exactly when to buy or sell a particular stock. Many studies have shown that investors who buy and hold individual equities can earn the best long-term returns, although past performance cannot guarantee future results.

Additionally, a company that misses estimates for one or two quarters can experience a turnaround that ultimately results in a higher stock price. An investor who sells shares immediately following an earnings miss could forfeit a longer-term gain.

Professional money managers work closely with analysts and also conduct their own research to establish whether a single quarter’s earnings report may be meaningful. Even if an individual stock misses estimates for one or two quarters, the portfolio manager’s task is to determine whether the stock may potentially generate long-term returns for shareholders. Ultimately, long-term returns are what matters for investors with long-term financial goals.

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