Here’s why stock investors need to pay careful attention to earnings season ‘report cards’

It’s a big week for stock investors.

Several of the biggest U.S. companies are reporting their third-quarter earnings to shareholders — making it perhaps the most consequential week so far this earnings season.

But what are “earnings” and why should investors care about them?

Earnings is a synonym for “profits.” After the end of each calendar quarter, publicly traded companies disclose their profits, revenues and other performance metrics to shareholders and analysts.

Think of the disclosures like a company “report card,” said John Butters, senior earnings analyst at FactSet.

The meat of earnings season is generally two to five weeks after a quarter ends, he said.

About 20% of companies in the S&P 500 — a stock index of the largest U.S. corporations — had already reported their Q3 results as of Friday, according to FactSet.

This week, 165 more are scheduled to do so. They include megacap tech names like Google parent Alphabet, Microsoft, Facebook parent Meta, Apple and Amazon, as well as firms like Boeing, Coca-Cola, Comcast, Ford, General Motors, Intel, JetBlue, Kraft Heinz, Mattel, McDonald’s, Southwest and UPS.

Company earnings are a key driver of stock price. Companies may reinvest their profits to grow the firm or return earnings to shareholders as dividends. Even healthy companies may sometimes report a decline in quarterly profit, but sustained earnings growth generally correlates to a higher stock price over the long term, experts said.

“To a certain degree, this is what capitalism is all about: It’s about profits, it’s about making money,” said Charlie Fitzgerald III, a certified financial planner and co-founder of Moisand Fitzgerald Tamayo.

More from Personal Finance:
Why a new $40,000 electric vehicle tax credit for business owners may be relatively easy to get
What investors need to know about the latest crypto tax reporting rules for 2022
63% of Americans are living paycheck to paycheck

But the stock market is a forward-looking beast. A company that reports financial metrics in line with expectations may not see its stock move much, if investors had already priced in those expectations.

“The market is always looking ahead,” Butters said. “What companies report now is sort of in the rearview mirror.”

Companies that surprise to the downside or upside may see short-term movements — falling by about 2% and rising by 1%, respectively, on average, according to FactSet. The metric measures S&P 500 company stock prices in the two days before and after an earnings report.

And disappointing earnings across a string of companies is generally a negative economic indicator.

Aside from company metrics, when companies release earnings reports, officers also prognosticate on future business and economic conditions during public calls with analysts.

These forward-looking comments are generally the most interesting information for investors — especially at a time when inflation is hovering near its highest level in decades, the Federal Reserve is raising borrowing costs aggressively and some market observers see a recession looming.

“Given all the uncertainty out there … the guidance is one of the focal points for investors this season,” Butters said.

Of course, stock investors are generally long-term investors — meaning the average person who’s saving for future goals like retirement shouldn’t make too much of one earnings report or season, Fitzgerald said.

Such investors are also likely saving in mutual funds or exchange-traded funds that holds thousands of stocks, meaning their portfolio would be insulated from any one company’s earnings.

“It’s interesting to know what’s going on, but [a quarterly earnings report] isn’t something that should push you to suddenly change your philosophy or approach,” Fitzgerald said.