What to Look Out For This Earnings Season

Every three months, the financial world stops what it is doing and listens to what the corporate world has to say about the performance of their businesses, industries, and their outlook for the near future. This is, of course, earnings season!

Why is earnings season so important for investors?

This is where the rubber meets the road. As investors we are fundamentally taking a view on the future every time we invest in a company, a stock, a bond, whatever the asset class. If we invest, for example, in the stock of a cloud computing business, one of the inherent views we are taking on that business is that it will continue to grow sales at a high rate and that operating margins will rise as that business matures.

Every quarter, the listed companies in that industry (as with all others) report and update their financial results publicly. This allows us as investors and the market to assess the reality of the performance of these businesses and reassess the validity of assumptions and forecasts. This process of informational update feeds through into the prices of those stocks. Better than expected results should, all else equal, lead to higher share prices, and vice versa.

The information the market receives every earnings season also helps to inform wider economic expectations, again feeding through into the prices of assets in financial markets. If many of the companies in, for example, furniture retail, report weaker than expected results and predict a slowing in demand next quarter, this can be read as a warning for broader consumer confidence and consumption patterns for the economy.

To cut a long story short, earnings season is critically important even in the best of times, and especially so in periods like now where there is great uncertainty about the future trajectory of the economy and financial markets.

So what should investors be looking out for this earnings season?

The elephant in the room is the US economy. Increasingly it is expected that the interest rate rises of last year should feed through into a slowing in the US economy, especially hitting consumption of goods hardest. Retail and online ecommerce businesses who rely on consumers buying goods will be important bell-weathers for US consumer demand and its outlook.

Similarly, how is enterprise spending looking? This is a great unknown currently. Will companies be cutting back their spending on IT, software, hiring of staff, etc. in response to the higher interest rates, inflation, and possibility of a slowing economy. This is an important sector in the economy and stock markets.

For those companies in China or with exposure to China, the re-opening of the Chinese economy and the expected impact on results later this year is going to be a major story for investors to follow this earnings season. Do the relevant companies think consumption patterns will return to pre-pandemic levels… will there be new or adjusted consumption patterns which may change things for certain industries? These will be important questions to answer.

We can also get a view on the likely potential trajectory of inflation from earnings season. Management teams will sometimes refer to their input costs and expectations for how that will pan out in the coming months. This can give us a head start on headline inflation expectations. For example, we’ve already had the CEO of a major consumer products company say publicly that they are continuing to see input cost inflation headwinds, and they do not necessarily think the inflationary cycle is over. What is the wider corporate world saying about inflation this earnings season? Another important one to be watching out for.