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Portfolio Update

The Right Stuff

By Roger S. Conrad, on May. 14, 2017

Earnings season always involves a deluge of information, but investors need to avoid getting caught up in the news cycle when evaluating how their holdings fared during the quarter. It’s the nature of business that some companies’ results will fall shy of the consensus expectations and some will surprise to the upside.

Although this artificial yardstick can drive stocks’ near-term performance, what really matters is whether the underlying business can continue to grow—that’s what builds sustainable wealth for shareholders. As long as a company’s growth prospects remain intact, investors should regard any earnings-related hiccups as a buying opportunity.

Remember that the stock market comprises a wide range of investors and institutions whose different objectives and strategies dictate how they react to the news. In many instances, their approach may not align with what’s in your best interests; follow their lead at your own peril.

When a pundit on CNBC discusses a company’s earnings, his or her main objective is to capture your attention, which explains why financial infotainment is rife with sensationalism.

Meanwhile, the press releases issued by companies aim to put their quarterly results in a positive light, which is fine when everything goes swimmingly. However, investors should be especially wary of companies that bury vital details in their press releases.

Tesla (NSDQ: TSLA), for example, didn’t provide a pro forma breakout of SolarCity, information that would help investors to determine whether the margin erosion and cash bleed at the residential solar-power business have continued to accelerate. T-Mobile US (NSDQ: TMUS) plays up its customer gains while sweeping its growing debt pile under the proverbial rug.

Computer-generated articles proliferate on popular financial websites. These pieces rehash earnings per share, revenue and other headline numbers with little context or analysis to indicate what the future holds for the company in question.

As a rule of thumb, the faster a comment is published or uttered, the greater the likelihood that it won’t include much insight. These remarks can and do drive some buying and selling activity, especially if the pundit or analyst is well-known.

But the best investment decisions usually occur when you take the time to put the numbers in context, investigate any questions that crop up, and debate whether the latest developments merit a shift in strategy.

If you keep tabs on company- and industry-specific developments between earnings seasons, the big surprise usually comes from how little actually changes. We also try to avoid negative surprises by steering clear of—or requiring a reasonable risk premium from— companies that have trouble meeting internal guidance on a regular basis.

Some stocks routinely rise and fall around earnings releases. Kinder Morgan (NYSE: KMI), for example, has rallied heading into its earnings release for the past two quarters, sold off after results went public, and then recovered its lost value. The old saw to buy the rumor and sell the news also works the opposite way.

Paying attention to these technical patterns can help investors identify better entry and exit points.

For us, earnings season represents the best time to check up on a company’s performance and determine whether we should stick with a position, buy more or head for the exits.

Given our longer holding periods, we look for hard evidence that a company’s underlying business remains healthy and can continue to grow—the surest formula for rising dividends and share prices.

This process involves checking the numbers in the press release and 10-Q filings and listening to or reading the transcript of the quarterly earnings call.

Remember there isn’t a magic number that encapsulates a company’s past and future performance. All these pieces of information—and insights from previous quarters—fit together to tell a story.

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