It's Expectations, Not Earnings

01/21/2013 9:45 am EST


Jim Jubak

Founder and Editor,

As we move further into earnings season, MoneyShow's Jim Jubak suggests you assess the market's earnings expectations for a stock, as those that surprise may do best.

For the week ahead, as we move deeper into earnings season, it's important to remember that what really counts for the way a stock responds to earnings is not so much what it reports, but what the expectations were.

Bank stocks are a really good example of this. For example, on January 16, before the New York markets opened, JPMorgan Chase  (JPM) reported earnings about 20 cents a share higher than analysts expected. The bank reported $1.39; analysts expected $1.19 for the fourth quarter.

But the stocks really didn't go anywhere. In fact, in early trading it was actually down about 1.5%, before recovering most of that ground and not rallying, but just basically holding steady. So 20 cents a share better than expected, and no real upside to this.

What's going on? Well, what's going on is that you've got a stock which had had a really good run along with the rest of the financial sector. JPMorgan shares were up about 32% for the 12 months prior to that. That's almost double the return on the S&P.

So you know there was a lot of people that had made a lot of money on this, and so the question going forward always is, well should I sell, should I continue to hold, do I want to buy some more, and investors looking at this decided there's not a whole lot here that makes me want to buy more.

What is it they didn't like? Well, it wasn't net interest margins falling, which had been something that had raised concern with Wells Fargo (WFC), another bank stock that had done really well, and again wasn't perfectly suited for investors going forward. With JPMorgan Chase, the problem that it had was the bank said, "Well, we'd really like to get to the Basel III bank regulation capital requirements earlier than we thought. We don't want to do it in 2014, we want to do it in 2013, so we're going to buy back fewer shares in 2013 than we'd expected."

That means that when you take earnings and spread them out over all the shares, earnings for shares aren't going to grow as fast as analysts had expected. So for example, Credit Suisse had about $9.5 billion in buybacks in its calculations of a target price for the stock, and then after the JPMorgan announcement, it said buybacks per quarter could be anywhere between $3 billion on the upside, which would be fine with its projections, or $2 billion a quarter on the downside, so $8 billion instead of $9.5 billion.

You had all these analysts who had put all this buyback money, all this into their target prices, now having to do recalculations. It's not a big deal. It wouldn't have been a huge deal if bank stocks hadn't run up so much.

When you've got a sector, bank stocks or housing stocks such as Lennar (LEN) or Pulte (PHM) where the run-up has been really big, earnings are being seen through the what have you done for me lately lens, as well as what are you going to do for me over the next month. So you get good earnings out of those sectors and expectations are so high, have been so high, there really is stock that doesn't go anywhere and good earnings turn into either a flat stock, or in fact in some cases a stock that's selling off.

That's one way to look at where we are in earnings season. The stocks that are likely to pop are those stocks not that report good earnings when they were expected, not that have had big runs, but that are reporting good earnings when they weren't expected. It's very hard to see a lot of that happening in this market, so it doesn't look like this earnings season is going to really drive the market a whole lot higher.

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