Lessons from Earnings Season and the Dog that Did Not Bark

As the Q113 earnings season reaches its close, there is a consensus around many conclusions:

• Earnings are growing at a rate less than the stock market. The P/E multiple is higher. Is this justified?
• Earnings exceeded expectations only because those expectations had been reduced. Is this a charade – the dance of the Wall Street analysts?
• Revenue was very disappointing. Companies were beating on the bottom line while missing on the top line. Can this continue?
• Corporations presented varying levels of confidence. Some saw a strong future, while many were more cautious. What does this tell us about the future?

The actual reports and the conference calls included plenty of discussion of these factors. Individual stocks gained or lost based upon the market reaction.

The issues are all valid. Investors should be skeptical about earnings, especially about projected growth. I always question whether current results flow from extraordinary measures. Can the success continue?

You also need to beware of biases. In the ’99 bubble era” there was a distinct bias toward optimism. Today it seems different. Many CEOs choose not to exude excessive confidence when nearly everyone is worried.

How Should Investors React?

All of the conclusions and questions are good ones. We study every potential stock purchase carefully, and so should every individual investor. If the company report does not verify your reasons for owning the stock, it is time to move on. I use the Seeking Alpha transcript search – a free resource for many conference calls – when I am unable to listen in person.

If the company is performing according to plan, it might be acceptable to ignore the market reaction, or even to buy more.

The key point is to test performance against your expectations and your reason for owning the stock.

The Dog Not Barking

Meanwhile, there are many investors who are not really monitoring earnings season because they are out of the market. They are not evaluating current holdings, nor are they shopping for any new ones.

Why not? They foolishly rely upon Tobin’s Q.

They have read about a Nobel Laureate (a great source, whose books I used to assign in class) or a perma-bear or two who have made a cottage industry out of selling these updates. They always warn you not to buy stocks. What would it take for this indicator to flash a “buy” signal?

The reason is that the underlying concept relates to a different era – manufacturing stocks and replacement costs. It has no relevance to companies like Google or IBM or Apple, or nearly any service-oriented firm. Try to apply it to the Buffett portfolio’s insurance stocks. Or Coke.

So check it out. Did any earnings season discussion of a specific company cite Tobin’s Q? I did not see any. I cannot remember one. It was Sherlock Holmes and the dog not barking.

If you cannot find an example either, maybe it is time to put this concept to rest.

Reader Challenge

With a little thought, my guess is that readers can think of one or two other market valuation methods that are completely unmentioned during earnings season. I didn’t see anyone discussing a company’s earnings from ten years ago, but there was plenty of talk about next year.

If you put these misleading ideas to rest, you will be free to join us in finding attractive investments.