Why are quarter profits a bad indicator for stocks?

[chewyer24]

I would assume that when quarter profits increase, a stock price would increase but this is not always true. Why not?

[Tom H]

Kiker is correct if you're looking for a really big pop.

Shake'n's answer is an even better general answer.

Here is my interpretation of how the pro evaluates an earnings report.

1) Look at earnings EPS and revenue compared to consensus expectations, with EPS most important.

2) Look at any guidance changes. An upgrade to the guidance levels for the next qtr or year is hugely positive, especially a big one.

3) Look for any changes in the gross margin or operating margin. If there are significant declines, or even small ones, this can be bad. Although RIMM just put in a great report yesterday, except for declining margins, and everyone still loved the report. I guess the declining margins were expected.

4) If we are talking about a retail store chain, then same stores sales comparisons can be very important.

5) If we have a hot stock on a hot run, then we need to consider "bars and hairs". This was a Jim Cramer tip.

If a company has beaten its earnings estimates by 10 or 15% for 3 quarters in a row then the "bar" gets raised a little every time by the analysts, or in investor's heads. So if the next qtr's earnings beat by only 6% (which is likely 'cause the analysts raised the bar) then it is perceived to be a miss in some investor's heads.

Or if the earnings beat by 10 or 11%, but there is any tiny problem; the problem is perceived to be like a hair in your soup. Tiny, but very unpleasant.

[Shake'n'bake]

There are several reasons why this can happen. The analysts may have been expecting even higher earnings. Or the guidance could have been disappointing. Guidance is much more important than earnings because guidance tells you what the company expects to earn in the future. Which is more important than what they did in the past. Or the margins may have narrowed. Or the inventory may have increased. Or a number of other factors which are more forward looking, while earnings are backward looking. Earnings are just one aspect of a complex picture.

[aceproceed]

Kiker is right. Ultimately, at the most basic level, a stock's value is simply determined by supply and demand.

Now, in a world where every person putting money into the market was well educated in economics and finance and bought based on a companies true strength or potential rather than at the break of certain news or short term data regarding it, things would be more predictable. But that's not how it works.

If other larger sectors of the economy are doing poorly, investors are less optimistic and may be unwilling to put money into or even will pull it out of a company totally unrelated to that issue which is doing quite well.

That's how a bubble economy works. Everyone is greedy and is convinced things will keep going up and before long all of the stocks are inflated at a value far beyond what their assets and earning potential really ought to warrent. Eventually, one person realizes this and gets out, then another, then another, and then the landslide begins and it all comes falllling down.

Perception drives the markets, not the realistic situation necessarily.

[Kiker]

You're right. But even when a company lists a record-breaking quarter, the market can still suck...taking that company down with it. The smaller the company, the less resilent it is to market forces....its all part of the violatility.
Take for example Taser: They had a booming quarter. Tons of international sales came in. They were sweeping through lawsuits. They posted 156% earnings, which, in a stable market would have meant a price explosion...but because of the financial sectors problems (subprime + credit cruch = Billions in write-downs) the entire market got tanked just off of a few poor earnings reports.

Its the nature of the beast, and it freaking sucks!!!!!!!

[NJ Gold]

Because these stocks are usually high flying market leaders, and if the quarterly numbers improve yet fail to meet analysts expectations or the whisper numbers on Wall Street the stock will get hit hard.

One quarter can be an exception, but usually when a company misses analysts estimates twice in a row it is often view by the street as a possible indicator the stock is headed in the wrong direction, then it gets sold off and remains a laggard until news breaks or the next earnings quarter report.