Each year around this time, investors and traders look to the various market analysts to get a glimpse of what the future holds for some of the major US stocks.
Analysist comb through mountains and mountains of financial and economic data to come up with what they reasonably believe to be a company’s ability to generate revenue in the foreseeable future, and more particularly the extent (quantum) at which they will be able to generate revenue. This is typically referred to as a company’s “earnings”
Most Wall Street bank analysists post their earnings expectations as a future looking figure i.e. what they expect the company to achieve.
Earnings Season for all intends and purposes is the time of the year (usually at the beginning and around each quarter) when companies would publish their actual earnings. These actual earnings are then compared to what the analysis anticipated (expected earnings) and any deviation has the potential to significantly drive a stock’s price up or down depending on the extent of the discrepancy.
Knowing a company’s earnings is also a quick measure to evaluate the relative over- or undervaluation of the stock based off current prices. As an example, one could say that at a given stock price, the share is trading at 10 times it’s earnings. In other words, a quick comparison as to how investors view the company’s growth and profit potential. This too is a helpful gauge at times when market prices are sold off, investors could look at a share and surmise that given the individual company’s ability to generate revenue (and future prospects) the market is undervaluing the share.
Seen below is a sample of earnings which are to be announced soon, Coca-Cola, Pepsi, Philip Morris, Unilever to name a few.
Visible here is the consensus Earning Per Share estimate published by the various Wall Street Banks.
We can therefor expect that with a number this closely followed, the market will react if this estimate of earnings is off by a large amount. If all analysts expect the share to earn 100 cents and the actual earnings the company was able to achieve is much lower – then clearly the market will react negatively as they rebalance their expectations and how much they are willing to “pay” for this.
Why is this though?
Earnings, dividends and Stock Valuation
Below is a video briefly explaining the impact of dividends on the pricing of a share.
While earnings shows a company’s ability to make a profit, dividends is the actual part of profits which are distributed back to the investors themselves – i.e. this is an actual payment (cash flow) received by the investors.
It is these cash flows (dividends) that forms a key part of many equity valuation models. By estimating the extent, value and frequency of the dividends and by discounting these at a suitable required rate of return, investors can estimate what the current value of a share “should be”.
Any disconnect in current market prices, vs this anticipated valuation will cause investors to either buy or sell the underlying shares in according to its perceived valuation.
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