What should you expect from the fourth-quarter earnings season?
Traders as well as investors should expect a very weak earnings season with extremely cautious outlook for the first-quarter of 2013. Consumer spending has been tepid which should leave over 75% of earnings with severe difficulties. The global economy has barely moved in any direction which further pressures earnings.
Having said the above, the most likely outcome is that the majority of companies will beat their expectations once again as they always have which makes it that much more important to understand why and how they have beaten expectations.
The most popular and most widely used approach in order to beat earnings is to guide well below what the company thinks it will be able to achieve. Apple is well known to always engage into this tactic. Each company knows what to expect and they usually guide lower six to eight weeks before the release, accept a temporary hit to their share price which will slightly recover by the time earnings are released. After earnings will beat expectations the share price will rally and usually ends up higher than when the lowered guidance was announced.
The second most popular tool is a heavy share buyback program which reduces the total amount of shares outstanding and therefore boosts the earnings per share figure. Since earnings are easily manipulated the P/E ratio is a worthless indicator in order to measure how cheap and equity is. There are plenty more accounting engineering procedures which can hide or cover losses and make the underlying company appear much stronger than it is.
It is also important to understand analyst ratings. The usually rate equities a buy, neutral or sell and most market participants do not clearly understand what the analysts are trying to communicate. A buy rating usually translates into a hold. When an analyst means buy the rating may receive the strong buy rating which means buy.
A neutral rating usually translates into a sell rating and the analysts firms will start reducing total exposure at a slow pace. A sell rating means that the analyst recommends liquidating the total position as soon as practical while an extreme sell usually means that the analysts has already sold the entire equity position.
Guidance is much more important and a bit trickier to manipulate. Companies prefer to guide much lower than what they think they can achieve which makes the downgrade to guidance that much more significant as it shows that business conditions are far worse than the already lowered expectations and therefore a great sign of concern.
Expect global equity markets to finish the first-quarter of 2013 lower than they closed the fourth-quarter of 2012 as earnings should disappoint even the extremel lowered expectations. Given economic as well as political issues stuffed in the pipeline we should see the start of a longer correction for equity markets.