The Little Secret About Earnings

TLDR:

At first, they seemed like a blowout: Amazon results last Thursday floored the market. Shares rocketed higher. When the earnings call revealed its cloud business was growing at its lowest levels ever, shares immediately dropped 4%. Tech companies are seeing growth slow from post-COVID hard-to-believe levels. But is earnings growth slowdown actually bad for stocks?

Tech companies were literally minting money during the pandemic as COVID drove dramatic behavior changes. They over-hired and over-spent as a result. Eventually, they had to confront bloated payrolls and other cost excesses as earnings growth came down faster than Icarus. They are still down a combined $372 billion in market valuation from a year ago.

When you look at the data, however, you find that a slowdown in earnings growth is not a bad thing. Not a bad thing at all … up to a point. As the chart below shows, when it comes to market performance, the “sweet spot” in earnings growth is actually somewhere between negative and positive growth.

Surprising, right?

The source of this otherwise surprising inverse relationship between the market and earnings growth rates is the stock market’s focus on several quarters into the future.

By the time earnings growth rates are extremely high—as they were until early in 2022 – —they have long since been reflected in stock prices. During such periods, the market has instead shifted its focus to earnings several quarters hence—to factors such as the Federal Reserve having to put the brakes on an overheating economy.

Note below the insight Toggle’s Investing Copilot generated back in March for Amazon: analyst forecasts had become too pessimistic, suggesting that there was substantial upside if earnings didn’t turn out to be quite so bad. The rest is history.

The point is …

The slowdown in earnings growth we are seeing has long been anticipated. Seeing it first hand is actually cathartic for the market – and may well be how the market low is ultimately put in.

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General Interest: An interesting speech on success and failure

The topic of failure is a major inspiration for Commencement speeches – think of Denzel Washington’s famous ‘fall forward’ one.

Last week browsing the WSJ we were led to an interesting take by Milwaukee Bucks’ Giannis Antetokounmpo.

A reporter asked him if he considered the game a failure (the Bucks obviously lost) and Antetokounmpo provided an interesting and articulate take on what it takes to build towards a goal.

Check it out on Twitter here and read the WSJ piece here ($).

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Originally Posted May 1, 2023 – The little secret about earnings