Don't let earnings reports blind you to better deals

Employees of Jefferies Execution Services work on the New York Stock Exchange floor Friday.

The Associated Press
Published: Wednesday, January 24, 2007 at 6:01 a.m.
Last Modified: Wednesday, January 24, 2007 at 12:00 a.m.

It makes sense for shareholders to closely track corporate earnings: It is the only chance for them to get a thorough report card on how business is going and often provides them with hints on the outlook for the months ahead.

Whether that persuades them to buy stocks is another story. Much attention gets paid to earnings every quarter, but overall market performance during "earnings periods" significantly trails the returns seen at other times of the year, according to research by Birinyi Associates Inc.

That suggests that investors haven't been wowed by the strong growth in overall corporate earnings quarter after quarter, despite all the talk about how that benefits the stock market.

Over the last few years, shareholders have had lots of good news. There have been 13 consecutive quarters of double-digit earnings growth at companies in the Standard & Poor's 500 index, tying a record set back in 1992 through 1995, according to Thomson Financial.

Expectations are for this quarter's results to be strong, though slightly weaker than what has been seen in the recent past. The growth rate for those S&P 500 companies that have already reported earnings as well as the estimates for those that will report in the coming weeks now stands at around 9.3 percent, according to Thomson Financial.

Earnings are coming in 6.1 percent above estimates, which tops the average surprise factor of 4.2 percent seen over the last eight quarters. Companies in the financial services sector are faring best, with earnings running 8 percent ahead of what they had forecast.

The good news — and bad, too — hasn't been lost of shareholders. Wells Fargo & Co., TD Ameritrade Holding Corp. and Schlumberger Ltd. all rallied in recent days after beating consensus estimates, while Motorola Inc. and Intel Corp. reported disappointing results and saw their stocks slump.

But the intense focus on earnings may be leading investors to miss out on better opportunities. In a note titled "Earnings Season Blues," the research firm Birinyi Associates looked back over the last 17 quarters at times when S&P 500 companies were reporting earnings as well as the "off season." They found a surprising gap in the cumulative returns: The market rose 12.97 percent when earnings come in compared with a 55.43 percent gain the other times of the year.

The divide in some quarters was more extreme than in others. For instance, during the reporting period that ran from July 7, 2004 through Aug. 12, 2004, the S&P 500 fell 4.93 percent while the market rose 6.34 percent over the next two months. Last summer, there was a 1.03 percent rise in the S&P 500 when companies reported results, but the gains seen after that were 5.28 percent.

Of course, getting investors to look beyond earnings season will be a challenge. For those investors who can't break the habit just yet, the market-watchers at Morgan Stanley have come up with some guidance on how to proceed.

With 71 percent of companies now reporting earnings that beat expectations — up from about 50 percent a decade ago — Morgan Stanley's chief U.S. investment strategist Henry McVey points out that trading on each quarter's positive news won't get investors far.

"Bottom line, 'beating' quarterly earnings estimates has become about as common as pumpkin pie during the holiday season," McVey said in a recent research note.

Instead, he advises the investment firm's clients to buy "consistent beaters" — those that have topped estimates for at least four quarters in a row. A portfolio of those companies, rebalanced quarterly, have outperformed the S&P 500 by 165 percent since 1996.

An example McVey points to is McGraw-Hill Companies Inc., owner of BusinessWeek and credit ratings agency Standard & Poor's. It has reported earnings ahead of or in line with consensus estimates for the last 40 consecutive quarters, and its stock has benefited as a result. Its shares have jumped from around $12 each a decade ago to just under $70 a piece today.

Clearly, investors who get ahead in today's market might want to think beyond the initial moves following earnings.

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