It should be a license to print money…
Imagine if you owned a crystal ball that could predict each company’s earnings announcement. With this crystal ball, you’d know with perfect accuracy which companies would beat analyst expectations and which would miss. And you could buy or sell stocks based on these flawless predictions.
This is the goal of every investor, right? Whether you’re a Warren Buffett-style value investor, a trend follower, or a day trader… at some basic level, you’re trying to figure out which businesses will earn the most money so you can put your money into those shares.
Predicting earnings does not mean you can profitably predict stock prices.
In a paper published last year in the Financial Analysts Journal, two professors computed the gains you could earn with such a crystal ball…
Back in the 1980s, your crystal ball would have earned you 4%-6% more than the market.
That’s enough to make you a superstar. Predicting earnings in the old days made sense.
But today, something has changed. In the years since, the advantage has steadily declined to about 2%.
Maybe the market is getting more efficient or various accounting issues have made earnings less reliable. You can debate the reasons.
But the point is this: Even with perfect predictions, you wouldn’t earn much… And of course, no one has a crystal ball. Even if you predict earnings with, say, 80% or even 90% accuracy… other factors and day-to-day market moves will wipe out that 2% advantage quickly.
We bring this up because we just had a strange spring. Multiple companies published stellar earnings… and then got beaten down by the market.
For instance, construction-equipment maker Caterpillar (CAT) beat earnings expectations by an eye-popping 33%. But investors saw a bearish warning in management’s comments that earnings growth may be “as good as it gets.” Shares plummeted 6%.
Defense contractor Lockheed Martin (LMT) beat earnings estimates by 18%, but shares fell by 6% that day as well. News outlets said it’s because Lockheed didn’t raise its cash-flow forecasts for the year, but we think those pundits were just grasping for an explanation.
Investors find themselves struggling in this market. After all, earnings should matter. And when so many stocks have what appear to be illogical reactions to their companies’ earnings announcements, it’s strange.
And it exposes some of the underlying characteristics of today’s market that are starting to concern us.
The market is a machine that weighs the consensus of all its participants. When the overriding opinion is optimism and investors expect better things to come, the market will rise. When everyone is scared, the market falls.
But other times, the market has no consensus… or it has shifting viewpoints. That’s when you see odd things happening – like good earnings leading to falling stocks.
Investors are confused. And to us, that means we want to stick with “boring” companies.
By boring, we mean businesses that consistently churn out predictable earnings quarter after quarter – companies like consumer-goods giant Johnson & Johnson (JNJ), beverage titan Coca-Cola (KO), and tech leader Microsoft (MSFT).
We want businesses that have customers locked into long-term recurring agreements. We want businesses with few competitors – and no new upstarts that could come and steal business away.
Many traders don’t like boring stocks because, well, they are boring. They don’t tend to move as much. But you can earn steady income on stocks like these, while taking on less risk.
This past earnings season showed us that investors don’t know what to expect. We find ourselves in a strange market… And for us, when the market is acting strangely, boring is best.
Here’s to our health, wealth, and a great retirement,
Dr. David Eifrig
Source: Daily Wealth