Earnings season is upon us!

For those who seriously pay attention to the stock market, earnings season is an important time each quarter. Earnings season is when companies report their quarterly financial results both in conference calls and press releases. It’s not only a chance to see how businesses have done, but, more importantly, it’s a chance to get a peek at how businesses will do going forward. And that peek, more than anything else, is what drives stock prices in the short term.

What are the prognosticators seeing in their crystal balls this quarter? For the first time since the second quarter of 2003, earnings are forecast to grow at a slower than 10% pace year-over-year. What many stock market watchers are worried about is that companies will not only report slower growth, but that they will forecast slower growth for more than a quarter or two. Gasp! Horror! (sarcasm)

In the long run, a stock’s price is determined by what a company will earn over time. The thing that moves stock prices in the short term, however, is not so much how companies are doing, but how they are doing relative to the view of market participants. John Maynard Keynes, a famous economist and successful investor, once compared picking short term investment winners to a beauty contest. Instead of trying to pick the most beautiful person, you end up trying to guess who everyone else thinks is beautiful. The game, in the short run at least, it to try to outwit all the other people trying to outwit you in guessing how everyone will react to short term information.

Would you like to guess how well this methodology works over the long term? Answer: not so good. The problem is that quarterly earnings reports and guesses about how things in the economy are shaping up are extremely noisy–by which I mean they move around a lot and don’t necessarily indicate long term information. This noisiness means that trying to guess what will happen seems to be a fools errand. And yet, most on Wall Street and most money managers try to play it. Want to guess why 80% of professional money managers don’t beat the market?

I’m not saying quarterly earnings reports are a waste of time. Quite the contrary. A lot of valuable information can be gleaned by listening to conference calls and reading quarterly financial reports over a long period of time. That’s why I read quarterly reports and listen to conference calls.

The problem is the importance that’s placed on such noisy data. And this importance is what makes stock market prices much more volatile than the earnings of underlying companies. It’s all those bozo’s trying to guess what will happen over the next 12 seconds that leads prices to go so far astray from underlying value. While such volatility makes consistently beating the market in the short term almost impossible, it does lead to wonderful opportunities to buy good companies at overly low prices.

And, that’s the real reason I love earnings season.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.