Earnings Beats Continue to Drive Markets Higher

When it comes to investing, I guess I'm old fashioned. There, I said it. I still dream of owning shares of companies that are growing, building businesses, expanding production, services, facilities and markets. But if you've been trading stocks for less than ten years, this perspective might appear archaic, outdated, downright foolish.

Gina Martin Adams, Equity Strategist for Wells Fargo was on Bloomberg TV yesterday touting renewed bullishness on US equities. Her enthusiasm was driven by the "75% of companies reporting earnings this quarter that exceeded analyst estimates". You can watch the full interview here. Tom Keene, the venerable host, for whom I have great respect, failed to ask the most compelling question: what percentage of companies reported earnings that actually exceeded prior year's results. After all, as old-fashioned as I may be, I still like the idea of owning shares of companies that are growing their businesses, not companies that are failing, but a little less badly than analysts had predicted.

We've discussed this topic elsewhere in this blog, in respect of US banks like Morgan Stanley and Goldman Sachs, then in a blog post just after Apple reported a stunning 27% decline in year over year quarterly earnings (the stock popped on the news, by the way). We saw yet more of this silliness yesterday as Polo Ralph Lauren reported a same store sales decline of 9%, with its stock up roughly the same percentage on the day. Today's pop is over at Macy's up 17% as of this writing on news of an earnings beat. Nevermind the fact that revenue declined by $230 million on a year over year basis, that the retail giant is shuttering 100 stores or that the company is forecasting a full year decline in comp sales of 3-4%.

But markets are markets and the market is never wrong, so what's going on here? My guess is that computer algorithms run by investment banks, hedge funds and other institutions are now programed to spot earnings beats, irrespective of overall company performance, and buy shares on the news. A beat is not always sufficient to drive a stock higher, but if it works in 90% of the cases, the odds are quite favorable for an institution trading hundreds of thousands of shares per day.

For the retail investor, however, this poses a great challenge. Do you seek out growing companies with rich stock prices, or beaten down companies hoping they'll fail a little less spectacularly? If you choose the latter, and I'm not arguing you shouldn't, bear in mind the risks of a miss on the stock performance of a downtrodden company as can be seen from market action following Macy's 2015 Q3 results.

Morgan Stanley Earnings Beat and Other Tall Tales of Wall Street

"Morgan Stanley Solidly Beats Earnings Expectations". That's the headline posted on the CNBC website this morning. Fox Business posted a similar headline reading "Morgan Stanley's 2Q Profit Tops Expectations". Nearly identical headlines ran yesterday when Goldman Sachs reported its 2Q results. The CNBC headline claimed "Bank Earnings on a Roll as Goldman Tops the Street". But drill down into the actual results and you'll uncover a far less bullish story than what the headlines would indicate.

Morgan Stanley, it turns out did beat analyst expectations on both the top and bottom line.  These were significantly lowered expectations, of course, based upon careful if not clever guidance of the company's CFO. But the numbers "beat" nonetheless. However, by all more traditional measures, Morgan Stanley had a terrible quarter. Top line revenues fell by $840 million from the same quarter a year earlier. A nearly 10% decline in revenue is hardly a reason to celebrate. Goldman's top line fell by $1.14 billion on a year over year basis, for a decline of 12.5%. The bottom line for Morgan Stanley was even worse than its revenue performance. Morgan's net income fell 12%, despite significant cost cutting. 

So how do stories like this get spun as "Morgan Stanley Solidly Beats Earnings Expectations"? Welcome to the new Wall Street. With investors trying to game the system in a through the looking glass economy, traders are solidly focused on earnings "beats" and misses. It's a desperate attempt to gain a trading advantage in markets that seldom make sense to anyone. The trouble is, an earnings beat tells us very little about the company's fundamental earnings performance or the growth trajectory of its business. It simply tells us about the skill of the CFO in managing earnings guidance. But year over year revenue and earnings performance tell us something very different. They tell us about the viability of the company's business plan, how customers are responding to the company's outreach and how the company is executing on its profit plan internally. Data points investors should be keenly aware of if they own the stock.

In the seven years following the Great Recession, CFOs have turned gaming earnings expectations into an art. They know that conservative guidance gives the company a lower bar to hurdle in reporting its results. And to the extent they "beat", well... Morgan Stanley stock is up 2% as of this writing.