Investing The Right Stocks Or Options – Earnings

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Nov 12 2006
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Research shows that earnings growth (Warren Buffett agreed to this as well) is the most important indicator of a stock’s potential to move upwards. Earnings, also known as net profits or net income, are what a company makes after paying all its obligations, including taxes and operating expenses. Companies often announce their earning quarters once every three months at the end of March, June, September and December, though some companies end their quarters in different months.

Companies report their earnings in two ways : a bottom-line total and a earning-per-share (known as eps) amount. The per-share figure is calculated by dividing the total earnings by the number of shares outstanding. The outstanding shares should inclusive of warrants (for some countries such as Malaysia) as you need to assume those warrants holders might convert / exercise their warrants anytime. Professional investors or fund managers love improving bottom-line growth and you can expect their thumb-ups.

Example: XYZ Corp., with 120 million shares, reports earnings of $76.8 million, yields 64 cents a share. The per-share amount is important for investors as it reflects how their initial investment has grown.

Many stocks that make major advances have another pattern specially in mature market such as Dow Jones. Their earnings accelerate over the previous three or four quarters (hence you can notice FinanceTwitter’s previous investments on stocks based on this factor). Acceleration means an increase in the earnings growth rate quarter over quarter.

Guidelines on what to look for when researching stocks :
  • Quarterly earnings-per-share growth of at least 25% over the same quarter the year before.
  • Preferably, accelerating earnings in the three most recent quarters.
  • Annual earnings-per-share gains of at least 25% over the past three years.

Strong companies with good and professional management teams, innovative products and leadership in their industries normally boast the best earnings and reflect the best investing potential.

  • Myth : You should buy stocks with low price-to-earnings (P/E) ratios.

The P-E ratio is a comparison of the stock’s price to its annual earnings per share. A stock with price-stock at $20 a share and annual earnings of $2 per share is said to has a P/E ratio of 10. In other words, the stock is selling at 10 times its annual earnings. Traditionally, investors would avoid high P/E justifying that it’s over-priced. But the truth (proven in market such as Dow Jones and Nasdaq) is best stocks (look at StarBucks, Apple, Google) often command higher P/E ratios. Investors are willing to pay some premium for good stocks, hence higher P/E ratios. The age of Warren Buffett in finding good stocks but with low P/E is extremely hard nowadays. Hence, don’t over-emphasize P/E ratio as the only method to compare a company’s stock relative to its earnings.

Where to search for companies earnings and P/E ? Some of FinanceTwitter resources :

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Hi FinanceTwitter :

Do take note that market expectation plays an important role towards the price movement of a share after earnings announcement.

If a company has been reporting good earnings & providing upside guidance for next quarter earnings during the past few quarters, investors would normally expect the company to report good if not better earnings and upside guidance in the next quarter. Sometimes stock prices are bid higher from such high expectation even before earnings announcement.

Thus when a company only reports in-line or just beats EPS or revenue by a little, or worst, gives downside guidance for the next earnings quarter, the stock would usually be punished severely.

But if the company is a growth stock which meets the criteria you mentioned but stock price pulled back because of the above reason, it’s a good opportunity to buy it at its weakness.

Yours Truly,

Tony Chai
My Options Trading Blog

hello tony,

you’re right … the intangible factor which is one of the most difficult to weight is the analysts’ expectation …

sometimes even if you beat the earning, give upside guidance, beat revenue estimates etc but provides “inventory figure” which doesn’t looks good, it will be punished as well …

it’s a risky business … but if the fundamental is extreamely good such as apple and you bought with good time value, chances are good for you to recover your losses ultimately …

cheers …

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