The biggest challenge investors face is trying to understand how what's happening to a company shows up in its stock price. The stock market often seems to move in ways that don't make sense, given the current investment climate. And although market volatility is inevitable, it isn't always very satisfying not to be able to figure out exactly what prompted a big market correction.
Many investors are having a lot of difficulty with the market environment right now. With strong corporate performance, companies seem to be doing everything the way their shareholders should want. But those successes aren't always producing solid returns for investors -- and recently, it seems like stocks have been punished even when current performance and future prospects look good. If you can get past that disconnect and stick to a solid investing strategy, then situations like these can produce great opportunities for long-term gains.
Another great earnings season...
Earnings season for the third quarter is winding down, and as we've seen earlier in 2018, the results have been exceptionally good. Among the more than 90% of S&P 500 companies having reported their earnings for the period, 78% have delivered positive surprises to their investors, according to data collected by FactSet. When you add up the total earnings for S&P 500 companies, earnings are almost 7% higher than originally estimated.
It's not unusual for the majority of companies to beat earnings expectations. That's largely because companies do their best to manage those expectations, hoping to reap the psychological benefits of outpacing the consensus earnings forecasts among those following their progress. Yet a figure of 78% is extremely high, in line to be the second-best percentage in the roughly 10 years that FactSet has tracked the number. The figure also marks the third straight exceptional performance for earnings in 2018, as the second quarter set the high-water mark of 80% for positive earnings surprises, while the first quarter weighed in at 78%.
From an aggregate earnings perspective, the numbers are equally impressive. The current projected rise would be slightly less than the 7.5% positive surprise from the first quarter of 2018, but otherwise, it would be the biggest since early 2011.
...but most investors don't care
Experienced investors know that a stock's performance generally matches up with its fundamental business strength over the long run. That's why under normal circumstances, you'll often see share prices jump after a company reports positive earnings results.
Yet markets don't always behave the way you'd expect in the short run, and there's been a big change in perception among investors despite the positive earnings news they've seen lately. Even with all the consensus-beating results, stocks reporting favorable surprises have seen gains of just 0.3% in the weeklong period starting two days before releasing their results and ending two days afterward. That's far less than the 1% bump higher that has typically occurred over the past five years, according to FactSet.
At the other end of the spectrum, investors have even less tolerance for the minority of stocks that aren't keeping up with their peers. Companies that miss earnings expectations have lost 3.1% on average, versus a typical 2.5% loss over the long run. Even those companies that manage just to match the investor consensus have seen losses of 1.4%, almost double what they'd typically suffer in a more normal market.
Don't lose confidence
When you own a stock, it's always difficult to deal with a falling share price when everything the company is doing seems to be going according to plan. Persistent losses even in the face of great business fundamentals can cause you to lose confidence in your investing thesis, and the temptation to sell out can be overwhelming.
Yet over the long run, growth in earnings gets rewarded. You won't always see it immediately, as metrics like P/E multiples can compress for extended periods of time. But if you have a truly long-term horizon that measures at least several years into the future, then taking advantage of shorter-term traders who don't focus enough on the big picture can leave you well ahead.
Successful investors find ways to be contrarian at opportune moments. When stocks make moves that don't make sense, that can open up great opportunities for investors who can get past the noise and concentrate on the true potential a company has for growth.
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