Equities are price valued based on the expected future flow of earnings.
It's really a cash flow game and this is why investors carefully watch earnings reports for prognostications of future profitability.
So far in the third quarter of 2011, earnings are off to a strong start with 70% of companies beating expectations.
When earnings numbers are released, we look carefully at not only the individual report relative to the company but seek to put the numbers in context to give us clues about the broader economy and macro trends.
Here are a few items to watch for when earnings are announced by companies:
1. The actual numbers: Earnings results summarize the financial cash flow position for previous quarter. It provides an indication of how the company is competing in the marketplace against competitors and the global macro environment. Because equities are priced based on future cash flow, earnings numbers help calibrate if the price set by the market is high, low, or about on target. It provides a signpost for valuation assessment.
2. Forward-looking guidance: Beyond merely providing guidance on last quarter's results, companies also provide indications of their expectations for their business in future quarters as well as their overall perspective on the economic global environment. These forward-looking statements are important, particularly in an environment mired in confusion and with economies clearly in transition.
3. Competitor view: While most companies are not interested in bashing competitors on conference calls, they often make comments about their competitive position. Comments can provide clues about the strength of competitor's offerings and which companies are possibly poised to create problems for a company's future prospects. Oracle is well known for providing their view on competitors in a rather candid manner(!).
4. Commentary tone and optimism/pessimism inclinations: CFOs and CEOs have emotions and are impacted by the environment just like anyone else. Though we often think that senior executives are immune from emotional reactions, excessive paranoia, and overt euphoria, that's not the case.
Some companies tend to be very conservative in guidance; these companies have a greater propensity to outperform earnings estimates because they've guided down the views of the analyst community. Apple , for example, is notoriously conservative when providing guidance. Other companies are perpetually optimistic on an ongoing basis and struggle to make projections. This tends to limit upside surprises and stock price momentum on a short-term basis.
5. Sector and geographic trends: Often executives on earnings calls make projections about what they perceive the future prospects are in a particular sector or in a geographic region. For example, an executive might talk about growth opportunities in Asia or difficulties in Europe which can give clues to their perspective about those region's economies. McDonalds often comments on ex United States trends when discussing earnings.
Intel often provides views on chips and the health of the technology sector when discussing their results.
6. Product and service announcements: Earnings calls typically are not where product announcements are made. Still, recent announcements are oftentimes discussed as well as the expectations for success for the product offering. Management conviction in the strategy being pursued by corporate executives is helpful intelligence as you assess the leadership of the company.
As you can see, watching earnings is not simply a matter of assessing a single number on a quarterly basis and making a binary decision if that company it is doing well or poorly. There is much to be gleaned from earnings announcements. Don't miss the opportunity to learn, digest, and conclude; there's more there than many investors realize to help you as you invest your portfolio.
Today Mr. Yoshikami will be a guest on CNBC's Closing Bell with Maria Bartiromo at 4:15pm/et to discuss this blog post and more.
Michael Yoshikami, Ph.D., CFP®, is CEO, Founder and Chairman of YCMNET's Investment Committee at . Michael is a CNBC Contributor and appears regularly on the network. YCMNET is a San Francisco Bay Area-based independent money management firm that provides fee-based wealth management services to institutional investors and individual investors. The firm works with clients around the world. Michael was named by Barron's as one of the Top 100 Independent Financial Advisors for 2009, 2010 and 2011. He oversees all investment and research activities of the firm and is actively engaged on a daily basis in the firm's securities analysis activities and determines the macro tactical asset allocation weightings for client portfolios. He works with YCMNET's investment team in integrating behavioral investing strategies with the firm's core fundamental perspective. Michael holds a Ph.D. in education, other advanced degrees, and holds the Certified Financial Planner® (CFP) designation.