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An Alcoa aluminum plant Indiana. Alcoa is scheduled to kick off earnings season this week.

Daniel R. Patmore, Associated Press - Ap

Schafer: Small shifts in earnings aren't what really counts

  • Article by: LEE SCHAFER
  • Star Tribune
  • October 6, 2012 - 4:49 PM

Alcoa's release of third-quarter results this week will mark the unofficial start of another earnings season, the stretch of just a few weeks when most publicly held companies release their quarterly results.

It can be a hectic time for stock analysts and traders, but earnings season for most of us is like a storm. You want to stay safe and dry while it's passing and then read about it the following morning. 

The folks out by choice in the wind and rain are likely traders, buying puts and calls in the hope of profiting from sudden shifts in a stock. For investors, by whom we mean people who carefully place capital into a productive enterprise to earn a return, whether a company misses expectations by a few cents is largely beside the point.

This isn't to suggest that it makes sense to ignore what companies say about their businesses. I read through as much earnings news as possible, but with the eye of an investor.

I try to not be annoyed that news reports sometimes can't even agree on what earnings for the quarter were in the same article -- with some paragraphs describing earnings and others using the same term but meaning earnings adjusted for unusual charges.

What's important is that the profit metric is clearly communicated and well understood by the shareholders, and that it is some approximation of cash flow or net income.

The quick news reports don't always cite the same factors behind an earnings outcome, either. Once you get past the earnings and look deeper into what happened in the business, there is even more divergence of coverage.

It happens in the business press and it happens with analysts. That there can be more than one smart take on a quarterly earnings report is not exactly surprising. In fact, it is encouraging.

In most cases, whether there was an earnings "miss" or a positive surprise is of little consequence to investors.

If you have invested in a company like Best Buy Co. for the long term, even the magnitude of the most recent quarterly earnings miss matters little compared with the fact that management can't seem to arrest a steady decline in same-store sales. Best Buy has a declining sales problem, not a short-term cost or profitability problem.

When any company reports its results, it's an occasion to consider management's strategy to compete and win. Sales and sales growth, new customers, new markets or fixes to failed strategies -- that is what is interesting to investors.

If it isn't obvious that a CEO has a strategy, that's even more interesting.

An earnings release also is an opportunity for the CEO to discuss the use of capital. Not all CEOs have the luxury of fat checking accounts, but cash and short-term investments held by non-financial companies in the S&P 500 remained in the neighborhood of $1.2 trillion as of the second quarter of 2012.

If managers can't come up with any better ideas for generating returns than whatever interest banks pay on cash deposits, then perhaps they should consider returning some of that money to the shareholders in the form of share repurchases or dividends.

A company's earnings release also provides insight into its industry, and the performance of an entire industry can have more to do with the performance of an investment than being shrewd enough to pick the stock of the industry leader.

Some industries, like banking, are broad enough that it makes sense to pay attention to a particular firm's results for what they say about a huge slice of the business community. Lower loan losses are telling us about improving economic conditions throughout a bank's trade territory, and not just that its borrowers happen to be having an easier time making their loan payments.

In the same way, what companies like Target say this quarter about the spending behavior of their customers is meaningful to businesspeople and investors in many companies.

There is an argument to be made that all of this talk about strategy and industry dynamics is quite sensible but sure isn't as much fun as trading around earnings. That was a point that came up in a recent conversation with the Minneapolis financial writer Jamie Dlugosch.

Dlugosch has written for online publications like TheStreet.com, published and edited a newsletter and served as CEO of Al Frank Asset Management. He's now the editor and principal voice for the Earnings Player, a subscription-based advisory service.

Dlugosch said he is not following any companies as businesses at all; instead, he's looking to anticipate swings in share prices around a quarterly earnings announcement that might be fun to trade through options. Alcoa's expected release has been on his calendar.

"I think part of the appeal for the earnings player is the game aspect of trading these specific events," he wrote in a quick follow up e-mail to our conversation. In addition to making money, "it's meant to be fun and exciting."

lee.schafer@startribune.com • 612-673-4302

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