When a company announces their earnings, it usually affects the price of the company’s stock, but not always as one would expect. Earnings season takes place during the weeks after the end of the quarter when companies announce their most recent earnings performance. Earnings announcements can have dramatic impact on the price of the company’s stock. Typically, if a company’s earnings exceed expectations the stock has an excellent chance to go up. However, if it meets or worse, misses expectations then the price of the company’s stock will drop precipitously. Also, what if a company tries to lower expectations and then beats those lower expectations? And do companies manipulate their earnings? What should an investor do during this turbulent time? Before we answer these questions, let’s look at an example. I am using Intel, a large and well run company that has a good reputation in the market and among investors for being open and complete in their communications with investors and analysts.
Intel’s Earnings Punished Their Shareholders Intel’s shareholders were punished on January 18, 2006 when the company announced its Fourth Quarter Earnings Report and the stock plunged 2.90 points or 11.4%. If you have access to a stock charting service you might want to look at the chart to gain a better understanding of the dramatic drop in share value. Needless to say, many investors were caught off guard. Since that date, those that are still holding Intel stock have continued to experience further losses. Not a pleasant experience.
The reason I choose Intel for this example is it is widely held, a quality company with excellent management and they have a very nice way to demonstrate the problem that can take place during earnings season. Please do not misconstrue my comments on Intel to mean that their management was trying to hide information from investors and analysts. They were not.
Intel releases their Revenue Announcements and Earnings Releases after the market closes on the day indicated. The market reacts to these announcements the next day it is open (some after market trading takes place, however, most of the volume is experienced the next day).
Let’s look at the events before and after this earnings announcement. On December 8, 2005 Intel provided the following release regarding their revenue expectations for the 4th quarter:
Intel Fourth-Quarter Business Consistent With kasegu-hyouban001 Expectations SANTA CLARA, Calif., Dec. 8, 2005 – Intel Corporation expects revenue for the fourth quarter to be between $10.4 billion and $10.6 billion, as compared to the previous range of $10.2 billion to $10.8 billion.
The fourth-quarter gross margin percentage expectation has been narrowed to 63 percent, plus or minus a point, and is expected to be slightly above the midpoint of the new range. The previous expectation was 63 percent, plus or minus a couple of points. Capital spending is expected to be below the midpoint of the previous expectation of $5.9 billion, plus or minus $200 million. All other expectations are unchanged.
Now let’s look at the part of the earnings release after the market closed on January 17, 2006, keeping in mind the revenue announcement above:
Intel Fourth-Quarter Revenue $10.2 Billion; EPS 40 Cents
Record quarterly and annual revenue and operating income
Record quarterly unit shipments of mobile, desktop and server microprocessors
SANTA CLARA, Calif., Jan. 17, 2006 – Intel Corporation today announced fourth-quarter revenue of $10.2 billion, operating income of $3.3 billion, net income of $2.5 billion and earnings per share (EPS) of 40 cents. Revenue was below the company’s updated expectation of $10.4 billion to $10.6 billion primarily due to lower than expected desktop processor unit shipments and prices. . . .
Fourth-quarter gross margin was 61.8 percent, slightly below the company’s updated expectation of 63 percent, plus or minus a point, primarily due to lower than expected revenue, a slight shift in the overall product mix to non-microprocessor products, and some inventory valuation adjustments to reflect lower unit costs.
First, note that the revenue Intel reported for the fourth quarter was below the ranges they had indicated in their Dec 8, 2005 announcement ($10.2 billion vs. a range of $10.4 to $10.6 billion). Also, their gross margin was below what they indicated in their Dec 8, 2005 announcement (61.2% vs. 63%, plus or minus a point).
As shown by the chart the market reacted positively to the revenue announcement on Dec 8, 2005. The price of the stock rose for several days, and then pulled back before rising again. Each rise stopped short of the previous high. If you believe in technical analysis, this indicates weakness, at least short term.