Monday, April 12, 2010

When Better-Than-Expected Isn't Good Enough

Earnings season is upon us again and, for the most part, analysts' forecasts are rather rosy. After all, corporations have slashed costs over the past two years. With some companies now seeing a pick up in sales, their bottom lines could see a nice jump.

Furthermore, as optimistic as the analysts are, their history in recent periods suggests caution. In other words, they have underestimated earnings more often than they have overestimated them. To some extent, they do this on purpose. After all, unless they are short, investors are more likely to get upset if a company falls short of the earnings estimate than if it beats it.

So we shouldn't be surprised if the majority of earnings reports for the first quarter come in ahead of the forecasts. The bigger question is how will the stocks react? Will beating the "number" by a penny or two be good enough?

The S&P 500 is up 7.5% year-to-date suggesting that investors are expecting stellar results for Q1. Given the strength of the rally, there is a good chance that stocks could sell off even if earnings beat the forecasts. I suspect this earnings season, "better-than-expected" will not be good enough.