The Biggest Lesson from Earnings Season

Here is a fresh take on earnings season. No matter how many sources you followed, you have not seen this before.

Let me start with what we did not hear.

  1. This stock is a poor investment because it has a bad Tobin's Q ratio. Readers are invited to correct me if someone is offering an opinion that Google has a poor replacement value. How do you even think in these terms? This method is an outdated approach in search of a modern critic.
  2. This stock is over-valued based upon the Shiller CAPE method. Readers are invited to correct me with examples of specific stocks where people think that the P/E ratio should be based on the earnings over the last decade, adjusted for inflation and divided by 10 (or some close variant). Has anyone ever made any money using this method?
  3. The earnings of the company should be ignored because it is happening in the midst of a counter-trend rally in the midst of a cyclical bear market. Readers are invited to correct me with examples of analysts on specific stocks who thought this was relevant.
  4. The current value of the company should be compared to its earnings in 1870. In 1910. In 1935. In 1950. In 1970….and so forth. Readers are invited to submit examples of recent earnings analyses where anyone thought this past history was relevant to the current stock price.

Stocks react dramatically to earnings reports. None of the price changes had anything to do with the factors above. None. No one ever makes a dime from applying these methods in real time.

What did we actually hear?

  1. Did earnings meet the Street expectations? How about earnings quality?
  2. Did revenues meet expectations?
  3. What is the outlook for the upcoming year – with special emphasis on macro concerns like Europe, recession chances, and China.
  4. Are there special factors affecting the outlook?

Every major stock move is explained in these terms, or a variant thereof. The ability to understand and answer these questions is the key to investment success.

The Overall Investment Implication

Anyone who thinks objectively about these questions is driven to a rather obvious conclusion about market valuation:

How can a method advertised as a good measure for the overall market fail to explain any of the components?

As corporate earnings move higher and expectations improve, most analysts conclude that the stocks in question are worth more. The market seems to agree.

There is another group of pundits who embrace Tobin's Q, CAPE, and cycles extending farther back than the dead-ball era in baseball. The enthusiasm of their followers approaches cult status. For these analysts the market seems to be in a permanent state of over-valuation. The followers are not investors, but merely spectators. They never get a "buy" signal.

A Better Method

Is there any better method? What if we could somehow create a network of sources that monitored all of the major companies? The sources would have to be professionals whose entire work would be devoted to studying specific companies. None would have to work with more than a few similar companies. These workers would question companies at a level impossible for most of us, challenging the assumptions and outlook, using detailed earnings models.

The sum of their conclusions would represent a comprehensive look at current earnings, revenue, challenges, and the outlook for the next year. Briefly put, it would aggregate all of the things that constitute the focus for each earnings season.

Ben Graham was brilliant. If such information been available to him, he would have found a way to use it. If only there was some way — somehow – that modern investors could find and use such a source.

Some would probably ignore the information, finding an excuse to validate their predisposition, whether supported by data or not. Those of us who embrace the best data and evaluate everything objectively would have an advantage.

If only we could hire such a work force? How much would it cost?

Where can we find such information? Any ideas? The answer might require some real contrarian thinking.

9 thoughts on “The Biggest Lesson from Earnings Season”

  1. Wonderfuk idea. If companies paid for rhe examination service to a general fund without any tie to the examiner then the company gets a gold star and investors know it is a company they can trust in good times and bad. Think of the Carmax ad where a couple goes into a car dealer picks a car & asks for the Carmax report. The dealer doesn’t have it so they walk across the street to a dealer that does. Would be hard to get the first pickle out of the jar and years to appreciate.

  2. “If only we could hire such a work force? How much would it cost?
    Where can we find such information? Any ideas?”
    I can’t afford to hire a work force, so I’m building a web scraper to collect earnings data (inspired by your past articles) and other related data to put into a database for slicing and dicing. Thanks Jeff for the articles the last few months about general econ conditions. I’ve stayed long most of the time and am happier for it.

  3. Basically, during the last half of a secular bull and the first half of a secular bear, the market is “permanently overvalued”. You have to find a way to “invest” (trade?) in spite of this, whether it be picking stocks that are “relatively under-valued”, or using trend or method timing signals.
    I use a “dead ball era” timing signal that has “worked” all during the past ~100 years. The problem with some other pundits is that for a while they used post-war sets of indicators (one who shall go unnamed…), and blew the past ~5 years. Then they went to indicators back to the early 20th century- oops, a bit tardy.
    On a related note, ~90% of individual investors should not pick stocks, or should do so with a fraction of the portfolio that is very small. And/or they should do some index hugging, trying to have similar diversification to a broad index with picking the “best” stocks.
    Thanks for your work.
    Kevin

  4. Forward earnings are available on Yahoo, Market Watch, FinViz, Google, and Seeking Alpha. What do you see as the deficiency? Personally I find those estimates problematic because they become dated (since new info comes out) and unless the analysts update their estimates based on the new information these websites continue to average the old estimate into the mean that is reported.
    It would be useful if a website were to detail the estimates (showing for example all 43 estimates for Apple, who, when,etc.) and perhaps show the google time line stock chart with the major news depicted, and overlay estimate changes. If this could be downloaded it would be awesome… as an individual could easily include and exclude data.
    I would use such data and weight more recent estimates, and weight more reliable analysts.
    What I find frustrating is that I can not find a decent way to look at P/E10 for segments. We get the S&P500, but what I want to know is whether a particular sector is undervalued representing an opportunity.

  5. Largely, throughout the course of the final 1 / 2 of the secular bull as well as the first half of the secular bear, the market is “permanently overvalued”. {An individual have got discover an effective way to “invest” (trade?) despite the, whether it is determining on stocks which are “relatively under-valued”, or perhaps using trend or system timing tells.
    I make utilize of “dead basketball era” timing signal that has “worked” every for the duration of the before ~100 years. The difficulty through a few different pundits is the very fact that for a while they utilized post-war sets of warning signs (one that will go unnamed…), and blew the past ~5 numerous years.
    Then the couple visited indicators back to the early 20th century- oops, a little tardy.
    Upon top of a related note, 90% of individual investors cannot choose stocks, or perhaps will need to do so right through a portion of the collection which is very little. And/or the couple should do some index hugging, attempting to have similar diversification to a wide-ranging index with deciding on the “best” stocks.

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