Price to Earnings ratio (or P/E ratio) is the most common fundamental term you’ll hear. Many investors consider the P/E ratio to be the quickest way to determine whether or not a stocks price is overvalued or undervalued. And you don’t have to be a rocket scientist to figure out the P/E ratio… simply divide a company’s stock price by the company’s earnings per share… or use my preferred method: www.reuters.com.
Generally speaking, when companies “report their earnings,” they are letting you know how profitable they are on a quarterly and yearly basis.
So… walk through this brief scenario with me for a moment and see if you can make “cents” of it all…
Company XYZ is scheduled to report earnings after the close of the markets on Friday. Every indicator is that they will meet or beat the analysts forecasts.
Friday roles around… the markets close and Company XYZ announces their earnings. Wow… not only did they beat the analysts’ forecasts, but they even beat the “whisper number” (an unofficial and unpublished number). As the company discloses their past results, they also lay out their expectations for the upcoming quarter and year. In this example, Company XYZ suggests their upcoming quarter will also see growth. How do you think the stock price of Company XYZ will open Monday morning?
Most people would suggest it will open up Monday morning… a few skeptics (or contrarians) may see a bearish opening…
The reality is, based on the information I’ve provided you, it is very difficult to know. So how can you determine after earnings are announced if a stock is likely to open up or down?
Well… the answer is in the analysts expectations. No, not so much of the most recent quarter’s results… but of the upcoming quarter. Before you can answer the question, you have to know: Is Company XYZ forecasting numbers that exceed the analysts’ expectations for the upcoming quarter?
You see, earnings are important… but expectations is where it is at. Stocks are less concerned with “what have you done for me lately” and a little more concerned with “what are you going to do for me now.”
Similarly, if a company has a poor quarter, missing expectations, but paints a picture of “glory days ahead,” you can almost be assured that the stock price will rise in the morning.
So, the next time you hear about a company announcing their earnings results and whatever other numbers they highlight about the past… be sure to tune an ear to what really matters. Expectations… even though they are not concrete, they are the numbers that really move the markets.
* This article was taken from the Investinthemarkets.com Weekly Newsletter. For more quality investment education and investment opportunities, visit here to check out the sample newsletter.