Earnings matter. With headlines focusing more on earnings reports and M&A activity than the minute-by-minute vote count in the Greek parliament, we are seeing how investors are taking the most recent quarter’s operating performance and the guidance given by company management. With only 36% of the S&P 500 having announced so far, 73% have beat estimates with an average surprise of 5.2%.
The stock market reaction though is all about expectations. This was illustrated best this week with two companies in the technology. On Wednesday, Apple posted numbers that showed pretty good profit margins. The company made $10.7bln in net profit from $49.6bln in sales. Sales of iPhone jumped 35% over a year ago. The problem was that investors expected more. Missing consensus iPhone unit volumes by 1mm units (and some analysts expectations by 2.5mm) the market pummeled the stock down almost 7% after the announcement (but ended the day down closer to 4%).
Meanwhile, Amazon stock surged 17% in after-hours trading on Thursday (though the optimism faded a bit during trading on Friday). What happened? Amazon turned a profit. After growing sales 20% to $23.2bln, the company cited net income of $92mm for the quarter. Why then does a company whose paltry earnings on such a large sales number fare so much better than a company who generated significantly more profit? Expectations. While Apple enjoys a strong product suite with high gross margins, it is perceived that they have saturated the market and there is little information of how the newly released Apple watch is contributing to growth. Meanwhile, Amazon is seen as having several growth stories from cloud computing to Prime delivery. So the stock market takes a little recent information, this quarter’s earnings and the tone of management in their forward guidance, and extrapolates into the distant future.
In the end, the real store of value in a company is its long-term sustainable earnings power and sending that cash flow to investors. While the headlines will be littered with individual stories of success and failure at the day-to-day stock popularity game in the market, focusing on talented management teams operating quality businesses with solid growth potential and the right capital structures enables investors to compound capital over time. And making money in the long run is always popular.
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