The Three Pathways to Profit as Investors Make it All About Earnings
By William Patalon III, MBA
Managing Editor
Money Morning/The Money Map Report
In the weeks to come, it will be all about earnings.
Stock prices soared to a new record high a week ago today (Monday), on a newfound belief that the subprime mortgage mess was contained. We predicted that belief would be short-lived, and that the rally would fizzle. And we were right.
By the end of the week, investors had come around to our point of view. They could now see that the fallout from the subprime crisis was still spreading, meaning the debt crisis was far from over.
Now we’re headed into earnings season. During such an uncertain stretch, profits will be as important as ever in determining which investments will fly, and which ones will founder.
In searching out stocks, look for:
- Companies that are earning at least half their profits from overseas. With the U.S economy in a possible slowdown mode, we’ve demonstrated that firms with an international revenue stream are best-positioned to weather a decelerating U.S. market.
- Firms that are not in the financial-services sector, since they may still have an exposure to subprime mortgage debt – even if that problem hasn’t yet surfaced.
- Companies that are based overseas: Look for the stocks of companies based in such promising markets as China, Japan, Korea and Taiwan.
The first wave of third-quarter will come this week, and investors aren’t expecting much at all. Standard & Poor’s Inc. is forecasting a slight decline in third-quarter results, but is then anticipating fourth-quarter profit growth of greater than 10%. So while the profit reports themselves are key, the associated “outlooks” may be even more important. The reason: Stock prices are “forward-looking,” meaning the prices will be a function of both the third-quarter numbers and the fourth-quarter outlook.
The third quarter was rough for the financial markets – even though stock prices are at record highs.
The market gains came as data revealed a growing jobs market in August and September, amid modest growth in the manufacturing and services sectors. Investors shrugged off warnings from Citigroup Inc. (C), Merrill Lynch & Co., Inc. (MER), and other financial-services firms, which all preannounced disappointing results for the quarter.
The Dow Jones Industrial Average rose 1.23% and is near record highs. The Standard & Poor’s 500 Index hit a record after gaining 2.02% last week, while the Nasdaq composite index climbed 2.92% pre-announced disappointing results for the quarter.
But any worse-than-expected earnings – or warnings of upcoming problems – could roil the markets.
"The relief rally has gotten us to this point," Joseph Battipaglia, chief investment officer at Ryan Beck & Co., told The Associated Press. "There continue to be lagging sectors, the biggest being, of course, the consumer."
On Friday, the Commerce Department reports on September retail sales, which economists surveyed by Thomson Financial expect to show an anemic gain. But Wall Street is forecasting solid third-quarter earnings from some big consumer brands – Yum Brands Inc. (YUM) today (Monday), Costco Wholesale Corp. (COST) on Wednesday and PepsiCo. Inc. (PEP) on Thursday.
Both Yum and Pepsi have substantial overseas sales. And Pepsi has just launched a brilliant marketing promotion in China that many experts say will help it grab market share from its much-larger rival Coca-Cola Co. (KO). Costco is important as a measure of consumer confidence, and consumer spending.
Tomorrow (Tuesday), Alcoa Inc. (AA), will be the first of the 30 Dow companies to release third-quarter earnings, and the aluminum producer is expected to report a modest increase in profits.
Another Dow stalwart, General Electric Co. (GE), will make its earnings report on Friday. GE is expected to post an increase in profit, even after warning last month that exiting the struggling subprime lending market meant the industrial conglomerate had to take a third-quarter charge of $300 million to $400 million.
News and Related Story Links:
- Money Morning Investment Analysis:
Avoid the ‘Resurgent’ Homebuilding Sector and Go Global for Profits. - The Associated Press:
Wall Street Looks to Earnings Reports. - Money Morning Investment Analysis:
Four Ways to Beat the Credit Crunch and Profit From Global Growth. - Money Morning Investment Analysis:
The Second Quarter Votes are in: Global Gains Trump Domestic Pains. - Money Morning Investment Analysis:
Pepsi ‘Goes Red’ in China.