Thoughts on Earnings Season
Board: Pencils Palace
Market emotions tend to come out in full force during earnings season. It can be especially frustrating to invest in a stock just a day or two before the business reports quarterly earnings, only to see the stock tumble in after-hours trading after reporting earnings. Of course, sometimes the opposite can happen and we see a stock skyrocket after the company reports results that please Mr. Market.
In case we needed any extra proof, earnings season is merely Mr. Market's way of reminding us that he has violent mood swings. Even Jim Cramer could look at Mr. Market during earnings season and say, "Holy cow, dude, take a chill pill." (Maybe interspersed with a few expletives and sound effects.)
The key is to focus on the underlying business. In the vast majority of cases, one quarter (or year, for that matter) is not going to make or break a business. If analysts -- despite their infinite wisdom -- are wrong, heaven forbid, with their projections of a company's performance... so what? I'm not investing in a business because analyst Joe Schmo issued a "BUY" rating with a "price target" 20% above the current share price. I invest in a business because I believe in the business and its ability to produce value for its stakeholders over the long haul.
As investors who look beyond Mr. Market's erratic actions, focusing on the bigger picture is critical. After a company reports earnings, ask yourself: is this company's long-term potential, and capability of executing to reach that potential, still intact? If analysts do overestimate a company's short-term performance and the stock is punished as a result, it may represent a buying opportunity for investors focused on long-term performance.
I remember when promising businesses like Chipotle, Netflix, Hansen Natural (now Monster Beverage), and others would get clobbered 15%-20% immediately after releasing solid earnings reports that beat analyst expectations in every imaginable category. Sometimes, Mr. Market just needs an excuse to unleash a concentrated dose of emotional chaos.
So, even if you invest in a business only to see it get clobbered 10%-15% after reporting earnings, stay focused. I sold plenty of promising businesses after getting spooked or discouraged by short-term results and stock price movements. Companies like Chipotle, Netflix, and Monster -- all of which were and continue to be volatile stocks -- have gone on to absolutely crush the market despite the occasional 15%-20% drop after quarterly earnings reports. Looking at a graph of those stocks today, you can barely decipher where those "huge" drops occurred several years ago.
In the long run the business is what will make or break a stock. This is especially important to remember in the heart of the volatility of earnings season. It's okay to get frustrated if Mr. Market is simply misinterpreting or entirely dismissing a great business in the short-term, but persist and keep the long-term in focus. We're investing in a market that is not necessarily geared toward long-term investors, but we will succeed by identifying (and investing in) quality businesses likely to succeed for many years to come.