As part of our judgment process, we have to compare the numbers in the earnings and sales reports to the expectations set by Wall Street analysts. Perhaps more important, though, we care about the company's outlook for the future, and how that jibes with the expectations. This outlook is typically given cursorily in the company's quarterly earnings release, but is much more in-depth on the conference call, at the end of management's discussion of the earnings and right before the questionand-answer session. That outlook is the single most important consideration when you are trying to decide whether to buy or sell a stock at the time it reports. That's why I always laugh-with scorn, mind you-when I see people trading stocks after hours without listening to the conference call. If the largest determinant of the future price move comes usually about ten minutes into the call, what the heck are these bozos trading off of? It's shameless and stupid, and I sure hope I don't catch you doing it.
What are we listening for in that outlook? We want to hear forecasts, particularly for the rate of change of sales and earnings growth. But the portion of the forecasting I care the most about is the direction given on future gross margins, because that can be a true indicator of what the business can earn in the future. The gross margin guidance is what will be used to try to figure out next quarter's earnings estimates. That will set the benchmark that has to be beaten next time. When you hear "Such and such company beat the estimates," I say, "That's nice." It can help a stock and won't hurt it, for certain. But when you hear "Such and such a company beat estimates and raised guidance," then I know the stock is going higher. That's because a raising of the guidance by the company in that one little moment on the conference call before the Q&A means that analysts have to change their views to be more positive about the stock, which means more upgrades, more price target increases and more promotion. Those are the fundaments of immediate increases in stock prices. That's the only earnings "surprise" you should really care about, not the "better than expectations" stuff that you are normally told should matter. "Beat estimates" can matter. "Beat and raise," shorthand for "beat the estimates and raised guidance for future quarters," is what matters most. That's the crucial phrase you need to hear to bet with a stock instead of against it. That's when you know you have a winner, even if the unseen forces are playing havoc with the stock that day. If you keep a file of the "beat and raise" stocks and you buy them on down days, you are going to be investing carefully and making a boatload of money despite the noise that seems to weigh on stocks on a daily basis.
Text copyright © 2013 by J.J. Cramer & Co. From JIM CRAMER'S GET RICH CAREFULLY, reprinted with permission from Blue Rider Press, a member of Penguin Group (USA) LLC