Let's face it. In the new global economy, there will always be fears adding downward pressure in the short term. Some market someplace will always have debt issues, there will always be turmoil in some part of the globe, and some sector in the economy will always be experiencing a pullback or a correction. It's a fact of economic life. So what should we be focused on in the weeks ahead? Fundamentals. At their very core, stocks are based on the fundamental economic health of individual companies. Understanding how all of the external pressures impact the bottom line of those companies is our guide to determining if a drop in stock price is a warning sign to flee for the hills or if it is a perfect buying opportunity at a nice, low price resulting from the irrational fear of others.
The week ahead will provide a very good glimpse into the health of this earning season. Wednesday and Thursday will see some very important earnings announcements that will provide a good indication as to the overall health of various sectors. On Wednesday, JP. Morgan reports at 7:00 AM, and Wells Fargo follows at 8:00 AM. On Thursday, Bank of America leads the way at 7:00 AM, and the others to watch on the financial side are Charles Schwab and Citigroup. These are all financial stocks that will provide insight into the banking and brokerage sides of the market. The one other stock to watch, though, is Intel. They report after market close on Thursday, and they may well be a harbinger of the technology sector's performance.
Remember, there are three aspects of an earnings announcement that are important. It's not just the final p&l number that we care about. Of course, we want to watch the earnings number, certainly. That is an excellent indicator not only of the profitability of that company in the prior quarter, but it also gives you some insight into the accuracy of analyst expectations for that company and that sector. Did they meet or beat expectations? If they missed, is that an indication of corporate under-performance or were the analysts way off in their analysis of that industry?
Pay attention to their revenue stream in comparison with prior quarters and with the same quarter the previous year. If earnings improved, but their revenue stream didn't, then is there really a potential for continued growth? Expenses can only be cut so far, as they represent a finite component of the balance sheet. We really need to see improving revenue, since there's theoretically no limit to that side of the equation. I'm always cautious about companies that show strong earnings on weak revenue. There's a limit to their growth potential.
Most importantly, pay close attention to forward guidance. What pressure does the company foresee over the next year and what are their plans to counter that pressure? If earnings or revenue were less than expected, what are their plans for improvement? Is the CEO another Baghdad Bob screaming "all is well" while the building is crumpling around him or has he given us a very candid assessment complete with a solid growth plan? Of all the components of an earnings announcement, this is the one to which I pay the most attention. As either a trader or an investor, I'm far less interested in where a company has been than I am in where that company is going. Entering a long or short position on a stock is a forward looking position, so we absolutely must know that company's plans for the future.
It's early in the earnings season, and we can expect a bit of volatility. By paying close attention to these early announcements, though, we may gain a good sense as to the direction of individual sectors and to the market as a whole. If Wells Fargo, Bank of America, and Citigroup come in strong, it's a good sign that the banking sector as a whole may report strong, and there may be some excellent short term trading opportunities around subsequent announcements this season. Likewise, if they are weak, it may be time to go short on some of the weaker players in that sector or, if nothing else, wait for their drop and pick them up at a bargain price a week or two later.
There are some interesting economic data releases coming out this week as well, but we'll reserve that discussion for another post. Good trading!