One thing that sometimes gets overlooked in the day-to-day gyrations of the stock market is how well are corporations doing. Every three months companies formally report their results, though retailers and auto companies also give monthly sales figures.
Most public companies reporting coincides with calendar quarters, though some corporations do report their results on a different monthly sequence.
Quarterly reports tend to peak around the third to fourth week after the end of a calendar quarter. When companies report their results, significant movements in their stock prices often occur, depending upon how market participants interpret the figures.
What matters most for a company’s stock price is how the results compare to expectations.
For example, a company that has an earnings increase of 8 percent when expectations were for a rise of 10%, will likely see its stock price fall. However, a company that reports a 4 percent rise in earnings when expectations were for 2 percent, will likely see its stock price increase.
Oftentimes what is more important for a company’s stock price is what future guidance might be.
Corporations commonly will report their results and then hold a conference call later where the results and future guidance will be discussed. Sometimes a company may report stellar results and see their stock price rise initially, only for it to fall back later, when they issue future guidance.
With earnings season in full swing the past few weeks we have at least some indication of how companies have been doing. For the most part corporations are meeting expectations, but these expectations have been brought down in recent months.
Actual earnings for the market overall will likely be down modestly versus the same period last year. This is largely due to the dramatic decline in the profits of energy related companies. Excluding the energy sector, overall earnings would be up modestly, but then many companies do benefit from lower energy prices.
If you look at stock market performance during the month of January, the weakness was in the first part of the month before earnings were released. During the time frame of when the earnings have been reported, the stock market has performed somewhat better, implying that the earnings have been meeting expectations.
While overall profit growth for many companies has been fairly stagnant recently, the actual level of profitability still remains quite high. This means that profit margins remain above historical levels, though down from their recent peaks. With profit margins still relatively high, future earnings growth will likely have to occur more from revenue increases versus cost cutting.
The basic definition of profit is revenues minus costs. With the U.S. economy growing relatively slowly over the past decade many companies have been able to increase revenues from overseas sales. However, the strong U.S. dollar in the past year has hurt many companies overseas results.
Companies can still increase profits with weak revenue growth, if they are able to control costs. Costs can consist of many items, and will vary by type of company, but the two main ones are labor and materials. As the unemployment rate is falling, labor costs will start to increase more, and corporations can only manage that cost, if productivity starts to increase more. Material costs are currently favorable with low commodity prices.
2015 was a disappointing year of earnings for companies overall. This explains to a large extent why the stock market has not performed well over the past year.
Overall earnings for 2016 will likely see a small increase versus last year, as revenue growth will remain modest given slow global growth. It is unlikely that the U.S. dollar will increase to the extent that it did last year, which will be less of a hindrance for companies with international operations.
There are other factors that can influence stock prices besides earnings, especially in the short run. The key ones being interest rates and the level of risk in the financial system.
However, over time stock prices do correlate with earnings. Earnings will likely increase at a lower pace going forward than we have seen historically. This would imply a stock market still increasing, but with lower annual gains than we have been accustomed to.
