Following last Friday’s brutal jobs report, investors are starting to doubt the staying power of the economic recovery – and, in turn, the staying power of the current bull market.
But please don’t jump on the worry-go-round.
As I’ve said before, it’s not macroeconomic factors that ultimately determine the direction of share prices over the long term… it’s earnings.
So forget about obsessing over the gloomy economic headlines.
Instead, we should be focusing on the latest financial reports coming out of corporate America.
And we’re about to get bombarded…
So before you lose your head, here are the only two statistics we need to track as the earnings activity heats up…
Show Me the Revenue
Early on in the recovery, companies engaged in furious cost-cutting to boost profitability.
But there’s only so much fat you can trim, and you can’t cut costs indefinitely. We’ve essentially reached that point.
In order for companies to meaningfully increase their profits, they need to increase selling prices and/or sales volumes.
~ Earnings Watch #1: Gauge a company’s success by simply monitoring the top-line sales figures being reported.
Take the last quarter, for example. Sixty-seven percent of companies reported stronger than expected sales. If we expect the market to keep charging higher, we need to at least see a repeat performance in terms of the percentage of companies who beat revenue estimates.
It’s All About Earnings
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However, boosting the top-line numbers doesn’t guarantee a boost in profits.
For instance, increasing commodity prices could lead to a rise in expenses – and, in turn, eat into profits. So…
~ Earnings Watch #2: In addition to reporting better-than-expected revenue, companies also need to report better-than-expected earnings.
In the first quarter, 59.5% of companies were able to pull off this feat, according Bespoke Investment Group. If companies can top that beat rate this quarter, we should expect the stock market to keep rallying. And anything above 65% would be particularly bullish.
Don’t Put Your Faith in Analysts
In the end, the contrarian in me is optimistic that companies can top last quarter’s earnings and revenue beat rates. Why?
It has nothing to do with the economic data.
Instead, it’s because analysts are particularly glum right now and because they have a penchant for being wrong.
Consider this: For 10 consecutive weeks, analysts have revised net earnings expectations for S&P 1500 companies downward. Essentially, they expect companies to report lower profits.
But I’m not buying. Especially since we haven’t witnessed such a streak of negative sentiment since the Lehman Brothers bankruptcy. And, as I’m sure you’ll agree, while business prospects might not be perfect now, they’re certainly not as dire as the fall of 2008.
Bottom line: Forget about the latest round of macroeconomic data. Just keep an eye on two figures this earnings season – companies reporting better-than-expected revenue and earnings growth – with more to come. That’s what will drive future share prices in the weeks and months ahead.
Ahead of the tape,