1. Money

Investors in Stock Market Ignore Earnings Expectations

Drama Around Reports Not Helpful to Long-Term Investor


Did you always get the present you wanted on holidays? If not, you understand the disappointment of unmet expectations.

In the stock market, disappointment usually means the stock's price is beaten down. The emotions of expectations are so powerful that companies (and politicians) attempt to manage expectations.

For long-term investors, expectations are not all that important. Whether a stock takes a hit or bounces up on whether it has met expectations, is misleading and dangerous to the long-term investor.

Every quarter, companies must report their key financial indicators for the previous three months. In advance of these announcement, the company "suggests" to the investing community what the results might be.

Analysts who follow the stock weigh in with their opinions on expected earnings per share - one of the key indicators reported.

If all parties are playing on the up-and-up, there will likely be little if any difference between the guidance offered by the company and the expectations of the stock analysts.

Even if earnings come in close to expectations, analysts and investors often dig down into the quarterly reports for more clues about the future.

For example, even if a company hits its earning goals, analysts may note that revenue growth is slowing or other financial ratios are showing signs of real or possible weakness in the near future.

It is helpful to remember that stock prices on a day-to-day basis are driven by supply and demand and often have little to do with the long-term financial health of the company.

Long-term investors buy the company and not the stock, which gives them a different perspective on financial reports.

Since they are focused on the long term, investors watch for signs the company may not be the market leader it is today.

The whole expectations drama that plays out on a quarterly basis has little to do with whether the company has the capacity to build wealth for investors over the years.

Much of the noise you hear around the stock market (it's up or it's down) is just that - noise.

Stock market traders are interested in price changes (up or down, doesn't matter). They have little interest in the long term. Unfortunately, most stock market traders are not successful over time.

Those that succeed may have vast resources (such as mutual funds, hedge funds and other institutional investors) and/or they do stock trading full time.

There are two times when expectations become important to the long-term investor: when you buy and when you sell a stock.

At these two events, you can become hostage to the expectations game. Often the best course of action is to avoid the quarterly drama of reporting, when you want to buy or sell.

One of the keys to long-term success is to be very thoughtful about at what price you buy. You should have a target price that reflects a discount of the fair market or intrinsic value.

This discount, known as the margin of error, gives your price room to move up and make you a profit.

A crazy earning reporting experience can destroy your margin of error, which is another reason to avoid the drama if you can buy at a different time.

On the other hand, don't fall into the trap of hoping the drama around earnings reporting will give you the discount you need to meet your price. It could happen, but that's not investing, it's gambling.

Although it is challenging, your best course of action is to ignore 90% of what you hear surrounding the stock market and focus on finding great companies and buying them at a discount that will give you room to make a profit.

Ignoring all of the noise that has nothing to do with whether a company is great or not, can be hard, but in the end you will more like find long-term success.

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