If you are a fan of horse racing you know the familiar refrain, "the horses have left the starting gate." That phrase applies nicely to the start of earnings season, that time of the month when publicly traded companies release results of the most recent quarter.
Finally, after a month or so of intense credit crisis focus, we get to see where we are at with respect to earnings. Why is this important?
Well, stock values are based on a discounting of future earnings, to the extent those earnings are weak we may better understand why stock values are dropping. Having actionable information is a crucial part of Rational Investing and critically important to determining a strategy for portfolio management going forward.
Per tradition, earnings season kicks off with Dow Industrial component, Alcoa (AA). On Tuesday, the aluminum giant reported results from the third quarter, and the news was not pretty.
For the quarter, profits were 50% lower than the same period last year. The company stated that it expects results to be negatively impacted by falling aluminum prices, slumping demand and high input costs. (See also: "Earnings Season: Expect Big Options Profits.")
As is typical during a severe economic slowdown, the company stated that it was halting capital spending for major projects. With sales down significantly, the company announced it was taking actions to preserve cash and keep its balance sheet strong.
Net income at AA fell to $268 million or $0.38 per share as compared to $555 million or $0.63 per share in the third quarter 2007. Analysts were expecting $0.50 per share.
Most troubling about the results is that estimates had been at $0.70 in August and lowered to $50 during September. The rapidity of the collapse in the market was even worse than expected.
It is that uncertainty that gives investors pause. Shares of AA had already been trading more than $10 lower since the start of September. Today, the market is shaving another 10% off its value putting shares at about $15.
AA is now below levels last seen in the prior millennium and a reflection of the difficult state of the economy in the U.S. and abroad. How bad will things get?
On one hand, shares of AA reflect the 50% drop in profits and would appear to be fairly priced at these levels. On the other hand, if the economy continues to falter, AA shares may fall further.
At this point, the company is taking appropriate actions, but there is little they can do about their plight. The silver lining is that as oil prices fall its input costs will be reduced. That will help margins during a period of declining sales. (See also: "Grow Enormous Profits This Earnings Season")
Then again, they may be forced to lower prices to keep sales flowing. It is a vicious cycle and not easily broken once started. I would look for shares to trade lower before jumping in at this point.
A multiple quarter recession needs time to heel. With that time, investors may be able to buy AA at lower levels.
This article was written by Jamie Dlugosch, contributor to InvestorPlace.com. For more actionable insight like this, go to: www.InvestorPlace.com and check out:
