So Far, So Good on the Earnings Front

We still have a lot of reports to come, but so far second quarter profit reports have once again come in very strong. Aside from the obvious, a fairly strong economy, I think there are two key reasons why we are seeing strong corporate results.

The first is clean corporate balance sheets. Public companies are flush with cash which gives them a lot of flexibility in managing their business. Excess cash has been used for acquisitions as well as share repurchases quite heavily in recent quarters. M&A can be very accretive if done right, and buyback programs can add a penny or two to the bottom line in any given quarter.

The second reason earnings have been so strong, in my opinion, is because managements have finally figured out that the key is to under-promise and over-deliver. This is true in any business, public or private. However, in the go-go days of the late 1990’s, stocks would only rise if the firms beat numbers and raised guidance every three months. CEOs had to be overly optimistic in everything they said in order to prop up their already richly valued stocks. As a result, expectations got way out of line and eventually the bar had to be ratcheted downward.

I think today is different. The trend has been to beat numbers and issue cautious guidance. This serves to hurt share prices right after results are released, but it brings expectations down for future quarters. Then, the company beats the reduced expectations the next quarter and again issues cautious guidance. The cycle simply repeats itself over and over again. Executives have finally figured out that hyping their company’s future prospects can end badly if they fail to deliver on the lofty promises.

Readers of this blog know that I’d prefer companies shun quarterly guidance completely. However, if they insist on giving out financial projections every three months, at least most are setting the bar low enough that they can at least hit, and often even surpass, their projections.