Stock prices can rise and fall based on a company's earnings performance, because profits reveal the financial health of a business and also indicate the economic conditions for earning profits more broadly. Long-term investors may not be swayed by one quarter of disappointing earnings, but some investors think more immediately and favor short-term profits. Earnings are not the only development investors focus on, but they are relevant during and before earnings season.
Two of the common comparisons used in quarterly profit results are performance versus analyst expectations and performance versus the year-ago period. Investors are often quick to reward a stock that surpasses the earnings expectations set by financial analysts and whose profits exceed levels achieved in the previous year. When financial company U.S. Bancorp did just that in its third-quarter 2012 earnings performance, beating both analyst estimates and 2011 third-quarter results, shares advanced nearly 2 percent as a result, according to an article on the "Bloomberg" website.
When a company's profit performance fails to match the expectations set by the investment community, investors often express their disappointment by selling shares. This was the case in 2012, when during the third quarter investors drove the price of technology company Google 30 percent higher to reflect expectations of a quarterly earnings report with no flaws, according to the "Wall Street Journal." When Google's earnings were reported and showed weaknesses, the stock subsequently lost 11 percent in value.
While it is not always feasible for a company to provide early earnings guidance, investors have proved they prefer companies to be as transparent as possible as soon as possible when it comes to profit performance. Whether a company has good or bad news to share, investors want to know in which direction profits are trending before the actual announcement. According to a 2009 study performed by financial analysis provider IntelliBusiness/eventVestor, companies that provided positive or negative early earnings guidance in the first quarter of 2009 had better stock-price performance in the days following the announcement than companies that did not.
While stock prices generally rise in response to earnings announcements that surpass expectations, this is not always the case. In the second quarter of 2012, after more than 20 percent of companies that are part of the S&P 500 index reported earnings, nearly 70 percent of those results were better than expected. Nonetheless, data company S&P Capital IQ was anticipating a drop in quarterly performance in the S&P 500 versus the year-ago period because investors were more focused on disappointing sales performance than rising earnings, according to an article on the Market Watch website.
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