January 20, 2022
Whether you’re a new or seasoned investor in the stock market, you’ve probably heard of earnings before. Maybe you’ve casually heard mentions of it in the media, tuned into an earnings call, or read up on the results from a company you’ve invested in. Earnings offer publicly-traded companies an opportunity to provide investors with a business update. As the name implies, they’ll tell investors how much money they made and lost. They’ll also refresh investors on their products, services, and initiatives. Earnings is instrumental to stock prices, investor understanding, and the health of our markets. Their importance is most clear during earnings season.
What is earnings season?
Publicly-traded companies are required to make quarterly and annual reports. Annual reports offer a polished overview of a business’s operating performance and activities at the end of a fiscal year. However, since quarterly updates are more frequent than the annual ones, investors have something to keep an eye on. Quarterly reports often contain all-important information on the success and activities of a business, and as quarterly implies, many companies will be hosting four earnings calls per year.
The government requires these reports to be made within roughly 35 days of the end of a quarter, which means that hundreds of companies will be rushing to file their earnings and host their earnings calls in a given time. This is what has come to characterize early April, July, October, and January as earnings season.
Why does earnings season matter?
A misunderstanding that some investors have is that a company’s earnings is all about the here-and-now. Quarterly reports will detail the finances, initiatives, successes, and failures of a company. However, these reports often offer a second thing: perspective. Many quarterly reports will include insights from a company’s management team, predictions about future challenges or opportunities, and guidance for revenue in the future. Investors will often use this information to model for future quarters, creating their own estimates. In that sense, earnings season is not just about the money being made, but the money that could be made. These two factors are instrumental to affecting market valuations and stock prices.
These estimates (both internally and externally) are valuable at a micro level for investors. However, at a more macro level, these insights could provide key information about the health of the economy or an industry.
What can we learn from earnings season?
There are ample reasons to be interested in the earnings for companies you’re invested in, but what about for the ones you’re not? In reality, many Americans own many more stocks than they think they do. Many Americans investing in stocks are doing so through index funds or industry-specific ETFs. This is why earnings season is so important: investors have an idea of how companies are doing. However, by looking at how certain companies are doing (say, companies in a certain industry) they can also see how industries or the economy are doing.
For example, the COVID-19 pandemic caused many companies and investors to drop their expectations for earnings. This is a reasonable expectation for companies during a global pandemic. You could then measure the recovery of companies, and the broader market, through their earnings. Some industries (such as financials and tech) became benefactors in the COVID economy. Others (such as industrials and energy) were less lucky. In short, earnings season is like a reality check for investors. It helps investors value stocks, understand industries, and see the market for what it truly is.