Why Earnings Season Matters

10/26/2015


It's tough to overstate the importance of earnings season.

Over the last 20 years, the S&P 500 Index rose or fell an average of 3.7% in January, April, July, and October, months when the largest number of companies declare quarterly results. In the other eight months, the index averaged a 3.3% move. These numbers ignore the direction of the move, considering only the magnitude. Take the market's gains and losses into account, and the comparison becomes more striking. In earnings months, the index averaged a 1.1% gain, versus 0.6% for the remaining months.

This study illustrates trends every investor should understand:

• On average, stocks are more volatile during earnings season than at other times. Stocks also tend to see larger changes in their Quadrix scores during months when they declare earnings.

• Most companies report March, June, September, and December quarters and declare earnings in April, July, October, and January. However, 12% of S&P 500 stocks operate on a different quarterly schedule, and in the most recent reporting period, 24% of stocks with traditional fiscal quarters declared earnings more than a month after the end of the quarter. Given the number of off-quarter earnings declarations and the volatility that comes with them, our study probably understates the effect of earnings on individual stocks.

• Over time, the release of operating results has had a net positive effect on the stock market, as evidenced by the higher average gain in earnings months. Of course, stocks may still stink during earnings season. The S&P 500 rose 2% in July and nearly 1% in April but declined 3% in January.

Every earnings season sparks a different reaction in the stock market, and all are tough to predict in advance. You might think stocks would perform better when profits are growing. And you'd be wrong. The correlation between the S&P 500's quarterly profit growth and its performance during the peak month of earnings season is minuscule, which hammers home a point we've made before:

Stocks tend to outperform when they exceed expectations, regardless of the level of those expectations. With that in mind, let's take a look at those expectations. As of Oct. 20, analysts polled by Thomson Reuters expected the S&P 500's third-quarter profits to fall 3.9%, a more pessimistic view than the 0.4% decline expected at the end of June and the 2.2% gain projected at the end of March. Analyst estimates for the next four quarters have trended lower in recent months.

While it's certainly more fun to be in stocks when profit gains are busting out all over, remember that the market reacts more to how results and guidance compare to expectations than to the raw growth numbers. At the moment, analysts expect profit growth to improve as the year progresses, accelerating to the midteens by the end of 2016. Projections for 2016 seem overly optimistic — targets so far ahead usually are. But of more import to the market's direction over the next few weeks is whether stocks can:

1) Exceed modest expectations for the third quarter. The index has topped analyst targets in every quarter since September 2009, and we expect more of the same in the third quarter of 2015. We'd like to see the index deliver higher profits; it probably won't take a big earnings gain to encourage investors. So far, with 17% of S&P 500 companies reporting. 70% have exceeded profit targets, above the average of 63% since 1994.

2) Provide encouraging guidance for future periods. These days, guidance is probably more important than quarterly results. The entire market will pay attention to what companies say they can deliver. We'll be watching, too.


Current Hotline

Stock Spotlight

Individual Stock Reports

ISRs make stock research easy!

Perhaps the most valuable two page reports available anywhere.

All the data you would normally have to plow through years of 10-K filings, earnings reports, and reams of market data to assemble — yours all in one concise report.

ISRs contain our proprietary Quadrix scores — find out how we rate all the stocks in the S&P 500.

Visit us at individualstockreports.com