A few weeks ago I wrote about the upcoming earnings season. That season started last week with Delta Airlines, JPMorgan, and Wells Fargo releasing results. In that article, I showed a table of different companies and the EPS estimates for this quarter compared to last year and the average growth for the last three years.
In that earlier article, I expressed concern about this earnings season because many companies are expected to report lower earnings than they did a year ago or at the very least the growth rate was expected to be lower. Granted it is very early in the season, and only 12 of the 20 stocks from that table have reported, but so far it is going exactly as I thought it would.
I amended the table this morning to reflect the results that we have seen so far. I added a few columns to the table to show the actual results, the year over year growth, and a column for how the growth in the first quarter compared to the three-year rate. Of the 12 companies that have reported, 1o saw earnings grow on a year over year basis while two showed lower earnings—Goldman Sachs and Honeywell.
Looking at the percentage growth in the first quarter versus the three year growth rate, there are seven companies whose first quarter growth rate was slower than the three-year average.
Like I said, this is really early in the season and five of the companies in the table that have reported are in the banking industry. Even keeping that in mind, the results are in line with what I expected. What has surprised me is the reaction from the stocks. I wasn’t sure investors were properly prepared for the lower earnings and the slower growth rates, but so far most of the reactions have been fairly good.
A few stocks have moved sharply higher after earnings, specifically Delta Airlines, JPMorgan and Union Pacific stood out. As for stocks moving lower, Abbott Labs is really the only one that stood out.
Again, this is a small sample size and things could change next week when we start getting more reports from the tech sector, but so far I am pleasantly surprised by the reactions. I have said it before, but it is worth repeating. I think investors worry too much about companies beating their EPS estimates when they should be concerned with how investors react to the earnings. It happens all the time where a company beats earnings and revenue estimates, but then falls. Personally, I think this is where the sentiment analysis is even more useful.
Checking a stock’s short interest ratio, analysts’ ratings, and put/call ratio can give you an idea of how bullish or bearish investors are toward a stock. If the sentiment is too bullish, it becomes difficult for the stock to move up after earnings—no matter how the actual report compares to the estimates. Conversely, if the sentiment is extremely bearish ahead of the report, the stock could move higher even if the results are lower than the estimates.
I was watching the movie Rounders the other night. If you aren’t familiar with the movie it stars Matt Damon and it is about poker. Damon’s character, Mike McDermott, talks about reading the other players as being more critical than the actual cards. That made me think about the way I analyze stocks with the fundamentals and technicals representing the cards, while the sentiment represents reading the other players.
If you know, or are pretty certain, that the vast majority of investors are extremely bullish ahead of an earnings report, that is an optimal time to make a bearish play on that stock. No matter how great the earnings are, there are bound to be investors that are disappointed and look to sell.
So far this earnings season, it looks like investor sentiment is somewhat tempered, and the stocks are reacting accordingly.