The markets saw a fifth straight week of gains last week. The S&P 500 closed above 5,800 for the first time, the Dow hit a new record high, and the Nasdaq came within 2% of its all-time high.
The third-quarter earnings season just kicked off, so we’re about to see a big wave of data hit the market. If you’re new here, earnings season is the period after each calendar quarter when publicly traded US companies report their quarterly earnings. The “season” begins two weeks after the quarter ends and lasts for about six weeks.
The greed mentality is strong right now, and I think we’re going to see that continue. Stocks are already trading at high valuations. Any good news during our earnings calls will act as validation for greedy thinking. This positive investor sentiment will then boost valuations even higher.
Getting caught up in this vicious cycle can seduce you into overpaying for stocks. And we know that overpaying means you’re going to earn a lower yield.
To prevent being shortchanged on income, you have to stick to the basics.
Stocks Represent an Ownership Share
There are two ways to think about shares, and they both apply whether you’re investing or speculating. When you buy a share of stock, you are buying a piece of the company. This is why a lot of financial metrics are reported on a “per share” basis. One common example is earnings per share (EPS). This tells us how much of a company’s quarterly or yearly earnings is attributable to each share.
We can also think of shares as the ticker symbol and share price as it appears on an exchange. But remember that this share price is the market’s perceived value of shares. Analysts and investors, of course, consider the actual earnings numbers behind the shares. But they are also looking at the macro environment and adding a subjective layer of investor sentiment to share valuations.
That’s the difference between investing and speculating. Investors focus on the company and whether it’s a long-term money maker. Speculators focus on the share price and whether they think it will move in one direction or another due to a catalyst of some sort.
In reality, most buying strategies are a little of both. So we need to recognize that there are buyers in the market looking at shares through both lenses. And that share price doesn’t necessarily tell you anything about the stability of the company.
Check the Numbers (at Least Once a Quarter)
I get a lot of questions about what numbers I look at when I analyze stocks. Unfortunately, I don’t have a magic set of formulas that spit out perfect stocks. My analysis includes 13 years of observing the markets and, more importantly, extrapolating movements based on implied investor sentiment.
One thing I don’t do is fixate on the numbers day after day. I do check in on my stock positions once a week. And if I’m expecting some company news, I might set an alert. During earnings season, however, you definitely want to monitor all your positions. Here are some things I check:
The top of an earnings press release will show the financial highlights. You’ll definitely want to look at those—with a critical eye. Don’t forget that the “highlights” are what the company wants you to focus on. And management wants you to think everything is ok, even if it’s not. So, take notice of what they chose to highlight.
Then make sure you go beyond that. I like to check sales, revenues, net income, and EPS. Instead of fixating on the number in isolation, compare it to the same quarter last year, as well as the previous quarter. If the numbers are going down, you’ll want to find out if it’s due to a one-time thing or a sign of a bigger problem.
A management team will adjust or re-affirm its full-year guidance expectations in the earnings report. If they are changed—especially if they are lowered—you’ll definitely want to look for management’s explanation for the adjustment. A change to forward guidance will affect investor sentiment. So, if you’re a long-term investor, a change in guidance could cause a stock to drop and hand you the chance to add to your position.
If a company earns recurring revenue, I want to see the subscriber numbers. For example, AT&T (T) is one of my favorite Current Yield stocks. Every quarter, I check the postpaid phone net adds and the fiber net adds. Other companies, such as software companies, will show the number of subscribers added. If these recurring revenue numbers are not going up, that could be a red flag.
Finally, you’ll want to figure out how the shares are being priced by the market. The most common gauge you’ll see used is the price-to-earnings ratio or P/E. It is calculated by dividing the current share price by the EPS. The P/E ratio is usually easy to find in the stock details provided by your broker or online stock data provider like Yahoo Finance.
If you want to take this a step further, I like to look at the average P/E for a sector. This puts the number into a bit more perspective.
Volatility is the only certainty that I can see through the end of the year. Smack dab in the middle, we have an election. Plus, we have two more Fed meetings with market expectations for further rate cuts.
Luckily, dividend investing withstands all different types of markets. And all we really need to do is stick to our strategy, stay rooted in the numbers and facts, and not let emotion sweep us away.
For more income now, and in the future,
Kelly Green
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