Published July 2001
When
investing, be sure
to study company’s earnings
It
seems logical to assume that, if a company is earning money, its stock
is a good prospect for investors. But not everyone thinks that way.
For example, many
people rushed to invest in the so-called “dot-com” stocks when they first
came on the market. And as soon as some of these dot-coms were introduced,
their stock prices took off.
Even while that was
happening, however, these same companies were actually losing money, quarter
after quarter. Nevertheless, even more investors swarmed to them, attracted
by their impressive sales and their very presence in a fast-growing market.
The great interest in these stocks drove their prices up to astronomical
levels.
The end result was
a group of stocks selling for extraordinarily high prices. That meant
investors were willing to pay ultra-high premiums for the privilege of
owning these stocks.
When reality set
in, and the high prices could not be sustained, many investors realized
the importance of earnings when evaluating stock performance. Like the
race between the tortoise and the hare, an approach that’s measured and
steady often provides better results than one that’s fast and erratic.
The dot-com example
illustrates that earnings — or a lack thereof — are important to a stock’s
success. But the earnings issue may not be as clear-cut as you’d think.
When looking at a company’s earnings, keep two things in mind:
- Strong companies
can still show poor earnings results. A company’s earnings can suffer
from any of a variety of factors: an economic slowdown, product difficulties,
etc. For strong companies, problems like these often may be temporary
— and a solid company with strong fundamentals usually can overcome
them. As an investor, you need the ability to look past a bad earnings
report and see a company for what it truly is.
- The market may
not immediately reward companies with strong earnings reports. Even
if a company turns in a good earnings report, its stock price may not
rise. Why? Because the market focuses its attention on tomorrow’s earnings
more than today’s. The market typically looks ahead at the factors that
may be affecting next quarter’s — and next year’s — earnings. Are the
company’s products well positioned for the future? Does its management
have a clear sense of where it wants to go? Looking at the bigger picture,
is the Federal Reserve likely to cut interest rates? And will consumer
spending remain strong?
These are the sort
of questions that the market needs answered before it expresses its confidence
in a stock and reflects that confidence in the form of a higher price.
Regardless, you still need to look closely at a prospective stock’s earnings.
If they’re weak, try to determine the cause. Are you looking at a temporary
setback, or does the company have real, long-lasting problems? And if
earnings are strong, does it appear likely they’re going to stay that
way?
You can learn a
lot about a company by looking at its earnings. It requires some time,
but if being an informed investor is your goal, the extra effort is certainly
worth it.
Eric Cumley is an
Investment Representative with Edward Jones Investments at 1201-C SE Everett
Mall Way in Everett. He can be reached at 425-353-2322. Edward Jones is
an NYSE-member investment firm with more than 7,000 locations nationwide.
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