How Earnings Affect Stock Prices

Every three months, earnings season is one of the most important times for stock investors . It’s a time to check in on your favorite stocks to see how the companies’ fundamentals are supporting market performance, reevaluate your interest in those companies and capitalize on expected price fluctuations.

Whether earnings results are positive, negative or somewhere in between, a company’s stock will react. Investors aware of these dynamics can approach earnings season with confidence and may be able to easily identify market opportunities. Here’s what you need to know about the relationship between earnings and stock price movements: What are earnings reports?

Why are earnings important?

Why do market expectations matter?

Can you use historical earnings performance to make future decisions?

Publicly traded companies are required to file financial reports with the Securities and Exchange Commission on a quarterly and annual basis. These reports serve as a biography of a company, listing important financial data that informs investors of the company’s overall health and stability.

Earnings reports are a quarterly snapshot of how a company performed over a three-month period. But these results can provide a window into how a company could perform in the future. As a result, investors react on the news, directly affecting stock prices in the short term.

One of the required SEC filings is the 10-Q, the quarterly financial report. This is the document most often cited when stock watchers and the business media talk about earnings. It includes unaudited financial documents and provides a view into the company’s financial condition throughout the year, as well as a narrative summary of the company’s highlights and prospects.

You can review the 10-Q to compare metrics like revenue, net profit/loss and adjusted profit/loss in the company’s most recent financial quarter to previous quarters to understand the financial health of the company. Investors can find a company’s 10-Q on its investor relations website or in the SEC’s EDGAR database, a tool you can use to search for publicly available information about companies.

The 10-K is the annual financial report publicly traded companies must file. The form provides a comprehensive view into the company’s financial status that includes audited financial statements. Form 10-K can also be found in the EDGAR database.

Earnings reports are important because they show the company’s profitability and overall financial stability.

These crucial financial statements are some of the most important documents for investors to review because they provide a window into the company’s income, expenses, debt, operations and other metrics that measure the company’s profitability.

Depending on how well or poorly a company performs in its earnings report, investors can decide how to approach their position in a particular stock.

Liz Ann Sonders, chief investment strategist at Charles Schwab, says it’s important to consider the stock’s price as it relates to earnings.

“The value of a stock is a function of not just the earnings of the company but what the price of the stock is,” Sonders says. Evaluating a stock involves looking at both its market price and earnings. This means looking at the price-earnings, or P-E, ratio, a key valuation metric for stocks.

Reviewing the P-E ratio over time shows you whether the current ratio is higher or lower than the historic trend.

Sonders highlights looking at the “E” component of the ratio. “If a stock is now trading at a much higher P-E ratio than it was years ago, but there’s been a significant improvement in the growth rate of the earnings, then that’s a different story than if you have a very expensive stock trading at a high P-E that’s had a deteriorating earnings profile,” Sonders says.

Investors can use the historical P-E data of a particular stock to compare it to itself during different time periods or to other stocks in similar industries.

Market expectations, as measured most commonly by analysts’ eanings-per-share estimates, set the tone for how the company is likely to perform. If earnings results vary from these expectations, a stock’s price can respond by moving up or down.When a stock’s performance is on an upward trend and its quarterly earnings are positive, you may think that its stock price will increase. There is a possibility, however, that the stock price could fluctuate on positive earnings or even fall in market value .That may sound counterintuitive. Why wouldn’t investors respond positively to the news by buying more shares of a company’s stock when it produces positive earnings growth?The answer: market expectations. If the company made money during a quarter and secured a profit but investors were expecting blowout earnings, the […]

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