This week a client asked me if we should load up on U.S. banks days before they announce their quarterly earnings. He thought these #business models probably did well so why not back up the truck and load up on these stocks before they make their numbers public.

I thought that if one client asked this question, perhaps other clients are thinking the same thing. Should you invest in a company days before they announce their quarterly earnings report?

The answer is no. Your investment #decisions should not be based on timing the market. To time the market successfully you need to be right twice. On the entry point which is the buy and the exit point which is the sell. You might pull off one or two smooth investment moves in your lifetime however the more market timing you include in your life, the higher the probability of going bust.

So, why are earnings so important?

The short answer is that you cannot do much in the stock market without understanding earnings. But what exactly does earnings mean and why do they attract so much attention?

First, when you hear company earnings think company profits instead. How do you quantify profits? The difference between revenues generated from selling a product or service minus the cost to produce that product or service. Revenues minus expenses equals earnings.

So again, why do investors care about earnings? Simple. Earnings ultimately drive stock prices. For example, strong earnings will generally result in the stock price to rise and weak earnings may cause the stock to drop. In some situations, a company with a surging stock price might not be making much money. In addition, rising prices could mean that #investors hope the company will be profitable in the future and therefore are willing to wait it out. There are no guarantees this will be the situation however it is more probable in my opinion if you have a “buy the business not the stock” mindset.

How are profits of a company treated?

When a company is making money, it has two options. First, the company can re-invest capital back into the business with the intention of expansion or improving efficiency. Improving #production time or reducing costs can ultimately lead to generating more revenues in the future.

Second, the company can take a portion of the profits and direct them to shareholders in the form of a dividend or a share buyback. With this approach you’re basically saying I trust management’s decision to re-invest profits back into the business instead of taking the cash. With share buybacks, you get your money right away. Typically, smaller companies attempt to create shareholder value by #reinvesting profits, while more mature companies pay out #dividends. Neither method is necessarily better, but both rely on the same idea that in the long run, earnings provide a return on shareholder’s investments.

Second, the company can take a portion of the profits and direct them to shareholders in the form of a dividend or a share buyback. With this approach you’re basically saying I trust management’s decision to re-invest profits back into the business instead of taking the cash.

What is this week’s takeaway?

Earnings are ultimately a measure of the money generated by a company and is the most important indicator of a company’s financial health. Earnings #reports are released four times per year and are followed very closely by financial professionals, investors and analysts.

In the end, growing #earnings are a good indication that a company is on the right path towards delivering solid return for investors. By understanding the importance of company earnings or the expectation of future earnings, you are more likely to own these businesses for the right reasons.

Have a great day!

Talk soon,

Michael