It's Earnings Season

Jared Burns |

It happens every 3 months. If Buffett had his way, it would only happen once a year. Regardless, it’s earnings season again.

Markets always look toward corporate earnings season to validate not only the current value of companies, but form opinions on growth going forward. That said, this earnings season is going to receive a bit more focus than most. The market, S&P 500, is currently sitting at 23 times earnings.

Let’s take a quick step back. When we say “earnings”, what we mean is earnings per share, or a company’s net income after taxes and any preferred dividends, divided by the number of shares outstanding. Put very simply, how much money a company has generated after they have paid their bills. To put it into numbers, if you have earnings of $1 million, with 2 million shares available in the market, then you would have $0.50 earnings per share. ($1 million dividend by 2 million shares)

Let’s take that one step further. A company’s “earnings multiple” or price to earnings ratio is just the price their stock is currently trading, divided by their EPS (earnings per shares). So, to continue our example, if it costs you $10 to purchase one share of said company, then the earnings multiple would be 20 (10 divided by 0.50). In typical “market speak” someone would say the company is trading at 20 times earnings.

So, to come full circle, the S&P 500 trading at 23x earnings, is just the average of all of the underlying stocks’ earnings multiples.

Why is all of this important? Well, historically speaking, 23x earnings for the market is on the high end of the average. Which, without factoring any other information, would make one think the market has become expensive. So, investors are looking toward this earnings season to see if companies have grown enough to substantiate current prices. Add to that, investors are also looking for guidance on the sustainability of growth going forward.

So far, earnings, like those we’ve seen from the major banks, have been coming in ahead of estimates. Over 80% of companies reporting so far have beat their expectations. This is good news. If this can continue, then likely the markets should be able to continue their move higher, albeit likely slower than the past few months.

We know markets will likely need to consolidate a bit, before making the next leg higher. Volatility and periodic pullbacks are par for the course. But that is the nature of investing. For now, if earnings season can continue to provide such positive numbers, then we should remain optimistic for decent year.