The media discusses several topics and one frequently mentioned is the earnings report or earnings season. We hear Company XYZ beat their earnings or Company ABC missed their earnings. These are corporate earnings which simply indicate how much a company has made or lost during a specific period. Earning season begins a few weeks after the last month of each quarter and are important in determining whether the company has sustainable growth and reasonable outlook for the long term.

Earnings are provided in a per share form (known as EPS) and distributed most commonly on a quarterly basis. This quarterly earnings per share reported is added to prior quarter numbers in order to calculate the annual EPS. This annual EPS provides the full year outlook. These quarterly and annual EPS numbers are compared to previous year numbers so investors know how well the company is performing. For example, if CVS Health Corp earned 10% more per share in the most recent quarter than a year ago (and they did), you would think that CVS has potential for growth. As an investor, you need to remember we are looking at past performance and it should be used as an indicator for how the company manages their financials.  We should also take a look at their sales growth. CVS Health Corp also earned 9.7% more in sales compared to the three months ended September 2013. These are really good numbers. Sales growth is not captured as much as earnings growth in the headline number but it should be.  The company’s annual sales is part of the net earnings.

What is the impact on the Stock Market?

Let me begin by saying that just because a company “missed” their earnings projection does not make them a bad investment. Companies may miss their earnings, meaning they expected to earn $1.02 per share and instead they earned $0.95 per share. It is well known in the investment world that companies get punished if earnings are not met, their stock price declines quite a bit. This can provide an opportunity to purchase the stock at a lower price knowing the earnings miss may recover during the full year. This being said, corporate earnings are a big factor in the health of the stock market and during earnings season the market becomes very active from all participants; investors, traders and analyst as they review their positions and take action where necessary based on the new data.   

Let’s take a look at 2014’s third quarter results for the S&P 500.

The ten sectors below identify the net results of all the companies that have reported 3rd Quarter Earnings, 464 out of 500. Top line shows the overall earnings growth for the S&P 500 at 9.06% and 3.99% for sales growth. The other columns labeled positive and negative outline how many companies from each sector have reported better than or worse than earnings/sales numbers compared to the expectation. Energy sector shows 27 companies reported better earnings growth with 16 companies reporting worse. I will drill down on those negative reported companies to find out why they missed the expectation. As I mentioned, missing your earnings expectation does not make the company a bad investment. We just need to find out why they missed and if it will be a repeat or one time event. The third quarter earnings reported for 2014 were strong and the S&P 500 has returned 10.9% as of November 17, 2014.

UI Journal - Corporate Earnings - 3QTR 2014 Earnings Season_Table

Where do earnings expectations come from?

The management of the individual company reports their own expectations along with many analysts.  Analysts do their own research to come up with their opinion for recommending a company. An analyst will have a Buy, Hold or Sell on each company they want to follow. Various expectations should be evaluated to form your own opinion or view. All of these opinions come into play when earnings are reported, as the results may lead to the analysts downgrading or upgrading their recommendation. These recommendations often have an impact on the stock price and sometimes the whole industry that the particular stock belongs to because investors may believe other stocks in that industry may report similar results. That is a short-term view and keeping your long-term view on companies is one of the keys to successful investing.

My view. Earnings reported can be “modified” to appear better than expected because the company can reduce their expenses, which does have an impact on their net earnings. Revenue/Sales is another story.  Sales numbers are just that – revenue earned during the quarter. It is important to find out both sides of any story and earnings are no different. Taking a look at sales growth is just as important as earnings growth when researching a company.

The media captures a brief detail on the corporate earnings results. And while the whole story may not get full coverage it is important to know what made up the company’s performance and a look into their sustainability and future growth.

Good Luck and know what you are invested in.