If you are an avid watcher of the business channels on television, you could not have missed the frenetic activity that accompanies the quarterly “earnings season” — the period when listed companies unveil their results for the latest quarter. In fact, the actual earnings announcement is often drowned by a veritable flood of analyst comments, Q&A sessions with the management and sound bytes from market players. All this is usually accompanied by sharp gyrations in the stock price of the company being discussed. Indeed, to find a stock battered by 5-10 per cent in a single day after ‘disappointing’ results is not an unusual occurrence.
Quarters as milestones
But if stock prices really capture a company’s earnings prospects over the next two-three years, why do results for a single quarter cause so much mayhem? Well, this exuberance is not entirely irrational. Here is why quarterly results influence stock prices.
Though the stock market typically values a company based on its estimated earnings over the next few years, the quarterly earnings announcements are milestones that help investors evaluate if a company is really on track to meet those expectations.
Failure to meet the market’s expectations for a particular quarter naturally means higher targets for the rest of the year. Numbers that are better than what the majority of players in the market expected drive the stock prices up, as that may warrant an upward revision in the earnings expectations.
In fact, stock price gains for the Sensex companies over the past three years have been driven, to a large extent, by them repeatedly delivering earnings that are higher than analyst expectations.
Cues to future
Another reason why the earnings season is such an action-packed one for the stock markets is that they often provide cues to future earnings, from the company’s management.
With disclosures improving, several companies use the earnings season to touch base with analysts and investors and update them on business developments.
Conference calls with analysts and the public appearances made by the company management, often give investors new insights about unfolding trends in the business as well as the outlook for it, over the next few quarters. The new information helps the stock market “reset” earnings expectations, triggering stock price moves.
Finally, the quarterly earnings season also helps to turn the spotlight on the earnings potential of the less-known mid-size and smaller companies. Remember; there is still a large cross-section of small and mid-cap stocks that are not yet tracked by an army of analysts. Stock prices for such under-researched stocks are often not shaped by formal “earnings estimates” or “consensus expectations” as in the case of the high profile companies.
Under the circumstances, the quarterly earnings announcement often serves as the only reference point for investors looking to evaluate such stocks. This is why the quarterly earnings season is often marked by frenetic activity in the mid-cap and small-cap space, with sharp jumps in stock prices shortly after a company’s results announcement. For some of the low-profile members of India Inc, the earnings season is the time to bask in a few moments of glory, fleeting though the stock markets’ attentions may be.