Earnings Season Preview: Forget Alcoa, Focus on These Two Numbers Instead

Published Wed, Jan 11th, 2012   Louis Basenese, Chief Investment Strategist

Don’t look now, but another earnings season is upon us.

Alcoa (NYSE: AA) officially got the ball rolling after the bell on Monday. And despite reporting a quarterly loss for the first time since 2009, the company’s bullish outlook for 7% growth in global aluminum demand in 2012 prompted investors to bid up shares and the market.

A note of caution: Don’t give into the Wall Street tendency to read too much into a single company’s earnings report.

For one thing, a commodity producer hardly qualifies as an adequate proxy for our largely service and technology driven economy.

Plus, with the latest economic reports surprising to the upside – like the Institute for Supply Management’s December manufacturing reading, and the Labor Department’s latest employment readings – we want to see signs of strength and optimism from the majority of companies, not just one.

So today, let me provide you with a rundown on the earnings activity ahead. Then I’ll share the two key metrics I think we should be focusing on as this earnings season unfolds.

Wait for It… Wait for It

Despite the hullabaloo about earnings and Alcoa this week, only 15 companies are scheduled to report results. Next week the total jumps to 97 companies. It’s not until the following week, though, that the activity really picks up with 398 companies scheduled to report.

Here’s a breakdown of the number of companies scheduled to report by each day:

You can go right ahead and circle January 26 and February 2 on your calendars. There should be no shortage of news to move the markets those days.

And as we get bombarded with these earnings reports, here’s a breakdown of the two key statistics we should monitor.

~ Key Statistic #1: Earnings “Beat Rate”

No doubt, longtime readers are tired of me saying this, but it’s a proven fact that stock prices ultimately follow earnings. As long as companies are producing more and more profits, stock prices are likely to charge higher.

The only problem? Profits aren’t expected to increase this quarter.

Standard & Poor’s expects fourth-quarter earnings for S&P 500 companies to shrink 3.9% from the third quarter. And if that happens, it would be the first contraction in 11 quarters.

Of course, those are just expectations. And actual results seldom match expected results. So if we want to discern the future direction of stock prices, we should instead monitor the earnings “beat rate” – the percentage of companies beating analysts’ expectations for profits.

Since 2003, 62.5% of companies have beat earnings estimates, according to Bespoke Investment Group. So any number above that average would be a bullish sign for the stock market.

~ Key Statistic #2: Guidance Spread

Since the stock market is a forward-looking beast, past results don’t matter as much as expectations for the future. Or as Howard Silverblatt, Senior Index Analyst at S&P Indices, says, “The guidance this quarter is going to be more important than the actual headlines.”

While companies aren’t required to issue guidance, we can track the guidance of those that do. Specifically, we can track the guidance spread – the difference between the percentage of companies raising guidance and the percentage of companies lowering guidance.

A positive spread indicates that more companies are optimistic about the future. And a negative spread indicates that more companies are pessimistic.

As a frame of reference, the guidance spread has ranged from -2.1% (3Q 2011) to 5.2% (4Q 2009) since the current bull market began. So any positive reading should be considered bullish.

Bottom line: Forget about Alcoa and earnings. It’s all about guidance. And the more companies that raise guidance, the more likely the stock market is to rally in the coming months.

Ahead of the tape,

Louis Basenese