Published July 2001

When investing, be sure
to study company’s earnings

It seems logical to assume that, if a company is earning money, its stock is a good prospect for investors. But not everyone thinks that way.

For example, many people rushed to invest in the so-called “dot-com” stocks when they first came on the market. And as soon as some of these dot-coms were introduced, their stock prices took off.

Even while that was happening, however, these same companies were actually losing money, quarter after quarter. Nevertheless, even more investors swarmed to them, attracted by their impressive sales and their very presence in a fast-growing market. The great interest in these stocks drove their prices up to astronomical levels.

The end result was a group of stocks selling for extraordinarily high prices. That meant investors were willing to pay ultra-high premiums for the privilege of owning these stocks.

When reality set in, and the high prices could not be sustained, many investors realized the importance of earnings when evaluating stock performance. Like the race between the tortoise and the hare, an approach that’s measured and steady often provides better results than one that’s fast and erratic.

The dot-com example illustrates that earnings — or a lack thereof — are important to a stock’s success. But the earnings issue may not be as clear-cut as you’d think. When looking at a company’s earnings, keep two things in mind:

• Strong companies can still show poor earnings results. A company’s earnings can suffer from any of a variety of factors: an economic slowdown, product difficulties, etc. For strong companies, problems like these often may be temporary — and a solid company with strong fundamentals usually can overcome them. As an investor, you need the ability to look past a bad earnings report and see a company for what it truly is.
• The market may not immediately reward companies with strong earnings reports. Even if a company turns in a good earnings report, its stock price may not rise. Why? Because the market focuses its attention on tomorrow’s earnings more than today’s. The market typically looks ahead at the factors that may be affecting next quarter’s — and next year’s — earnings. Are the company’s products well positioned for the future? Does its management have a clear sense of where it wants to go? Looking at the bigger picture, is the Federal Reserve likely to cut interest rates? And will consumer spending remain strong?

These are the sort of questions that the market needs answered before it expresses its confidence in a stock and reflects that confidence in the form of a higher price. Regardless, you still need to look closely at a prospective stock’s earnings. If they’re weak, try to determine the cause. Are you looking at a temporary setback, or does the company have real, long-lasting problems? And if earnings are strong, does it appear likely they’re going to stay that way?

You can learn a lot about a company by looking at its earnings. It requires some time, but if being an informed investor is your goal, the extra effort is certainly worth it.

Eric Cumley is an Investment Representative with Edward Jones Investments at 1201-C SE Everett Mall Way in Everett. He can be reached at 425-353-2322. Edward Jones is an NYSE-member investment firm with more than 7,000 locations nationwide.

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