How Do You Make Sense of Earnings?

By Jared Levy, Editor, WaveStrength Options Weekly

In my book, I detail the ways investors can interpret not just earnings, but other economic and social data. Today, I thought I would share some earnings season insight.

From Your Options Handbook:

[Finding] Stock Value After the IPO -- Once a stock begins trading publicly on a major exchange, the issuing company is required to meet certain criteria, such as reporting their earnings and audited financials on a regular basis. If a company is listed on an exchange such as the NASDAQ or NYSE, the SEC (Securities and Exchange Commission) and the exchanges themselves require the company to disclose detailed financial information on a quarterly basis (earnings reports) as well as to provide investors with an annual report (10-K report). This not only helps us to value a company, but this data should be used by you (the investor) to decide whether to buy, sell, or hold the stock. This is why I encourage you to invest in stocks that are listed on major exchanges and be wary of foreign companies that may not be subject to our same accounting rules and regulations.

Because of the ever-changing demand for a company's products or services, it is next to impossible to predict with 100% accuracy the amount of goods or services that will be sold to the public over a given period of time. This uncertainty, coupled with the fact that the stock market is also driven by the whims of its investors, makes it next to impossible to predict the future price of a company's stock (if it were easy, none of us would need day jobs).

Earnings, at the end of the day, are usually the strongest and most accurate measurement of the stock market's "real" health. Just about every professional trader, investor and analyst will look at the track record of a company as well as its expectations for future profitability before they make a decision to buy, sell or hold.

Financial analysts and other market participants estimate how much a company will profit and perform each and every quarter. They will publish these estimates to clients and to the public (your broker may offer these reports to you). If a company exceeds those expectations, then often, but not always, the company's stock will go higher. If the company fails to meet expectations, the stock may move lower or remain stagnant after the report as investors become concerned.

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Unlocking Secrets of the Markets

Earnings reports are not just report cards for what has happened in the past, but also checkpoints at which corporate insiders discuss their current and future strategy and decide whether or not there needs to be changes.

Of course, the report contains detailed numerical financial results, but more importantly, there is usually comprehensive commentary offered by executives about the state of the company, its sector and the economy!

The results and predictions offered in the report can be priceless points of information for you and me as well and are generally based on fact, detailed research and observations.

I always say I would rather hear information unaltered, directly from the source, and an earnings report is a great way to get it.

Conference Calls and Webcasts

You would be amazed at what you can learn from listening to an earnings report. Once you get past the financial jargon, there is often a Q&A session, where the company will allow analysts and others to ask them intimate questions about their business. This is where gems about the future can be found. I highly recommend you listen to a couple reports from companies that are contained in the Dow Jones Industrial Average.

Many investors don't realize that they have the ability to listen in on earnings conference calls and webcasts at no cost. To find when a company is releasing earnings (as well as expectations and links to the conference call) you can check out earnings.com or go to the "investors" area of a company's website.

Here is an audio link to Alcoa's earnings report.

Alcoa kicked off earnings season yesterday with a strong report. In other words, it earned more than analysts thought, yet the stock was down 4% in pre-market trading...

If they earned more than expected, why was stock was moving lower after the report?

Remember, I told you there are several components of a report. For Alcoa, its forecast for business over the next year and reduced profit margin spooked investors and sent the stock lower.

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What's It All Mean?

You can expect this earnings season to be somewhat strong in terms of profits, but there will be even stronger demand by skeptical investors. This means that companies have to not only deliver exceptional results for the past quarter, but give extremely optimistic projections for stocks to move higher overall from here.

Smart Investing Daily has been detailing the skittishness of the market and the fears and negativity that have been building in the stock and commodities markets. When investors are feeling anxious, they demand even better earnings results.

Remember that the market has rallied over 30% (S&P 500) since the July low last year and many investors have profits sitting on the table that they won't want to give back. This makes them more likely to sell, which I think may be the theme for the next couple of weeks.