How Will Company Earnings Reports Guide Stock Prices?

Sam Subramanian PhD, MBA

Third-quarter earnings season is just about to kick into high gear. Leading financial and information technology companies will be stepping up to the earnings podium shortly.

Bank of America (BAC), Citigroup (C), and JP Morgan Chase (JPM) will put the optimism implied in Goldman Sachs’ (GS) recent upgrade of large banks to test. Investors will get vibes from Google (GOOG), International Business Machines (IBM), Intel, (INTC), and Nokia (NOK) as well.

Will Company Earnings Guide Stocks Higher This Season?

The past earnings report season was a good one for equity investors. Even though most companies reported declines in revenue, investors were satisfied with seeing corporations report an improvement in net income. Upside surprises from Caterpillar (CAT), Goldman Sachs, Intel, and Merck (MRK) enabled equities to rise and maintain their upward momentum through the third quarter.

Expectations for corporate performance now are nearly not as low as they were at the start of the second quarter earnings report season. The S&P 500 has gained 16% through the third quarter and is up 58% from its March 9 bottom. Will stock prices decline or will the third-quarter earnings report season prove profitable for investors?

Reasons to be Optimistic on the Stock Market

The answer to the question will depend on how companies fare on revenue growth and forward earnings guidance, two factors uppermost on the minds of institutional investors.

There are reasons to be optimistic on both counts.

• Alcoa (AA) unofficially kicked off the earnings season last week. Supported by better-than-expected sales, the company unexpectedly reported a profit. Alcoa management also predicted an increase in the global demand for aluminum in the second half of 2009.
• The U. S. dollar has declined nearly 5% during the third quarter. Currency translation effects should help bump up foreign revenue of U. S.-based multi-nationals.
• The net worth of American households has increased for two straight quarters. The wealth effect from the rising net worth can facilitate revenue growth. Encouragingly, retail sales have increased from the year-ago level in both August and September.

Stock Market Predictions

With corporations having taken substantial amount of costs out, operating leverage will help amplify even a modest revenue increases into substantially higher earnings.

Some sectors are better-positioned than others to show positive year-over-year earnings comparisons.

Strong year-over-year comparisons of company earnings are expected in the financial sector with earnings on average increasing nearly 60%. Strength in debt underwriting and trading activities is likely to boost this year's earnings.

In the technology sector, analysts' are forecasting company earnings to decline 15% from the year-ago period. Stronger demand for tech gadgets in emerging markets can only partially offset the decline in U. S. enterprise and consumer demand.

If analysts underestimate company earnings and allow room for upside surprises, and corporations match their bottom line performance with top line growth, and confidence in future earnings, equity prices can gain further ground and continue to frustrate the bears.

Investors positioned in the right sectors can do better and get a leg up on the stock market.

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