Earnings: Decoding the Conference Call
Four times a year, investors get a chance to hear executives talk about their businesses in their own words.
Savvy investors can analyze not just the information imparted in earnings conference calls, but also the tone of CEOs and CFOs. Do they sound nervous, or hopeful? Confident, or uncertain?
As second-quarter earnings season begins, BusinessWeek asked fund managers what they're listening for over the next several weeks. Here are tips, some general and some specific to particular companies or industries, for interpreting this round of earnings calls. (Investors can listen to conference calls via the Internet or by dialing in over the phone. Call information is often provided in the "investor relations" sections of corporate Web sites.)
1. Financial-sector CEOs: How much clarity on losses?
The financial crisis has dragged on for almost a year, partly because of a lack of certainty about the losses in store for big commercial and investment banks. JPMorgan Chase (JPM) and Merrill Lynch (MER) report on July 17, with Citigroup (C) following on July 18 and Bank of America (BAC) on July 21.
Wall Street is expecting another brutal quarter for the financial sector from toxic debt and bad loans. But several fund managers say they're hoping to learn how much longer those losses will continue. Georges Yared of Yared Investment Research says the market is looking for clarity: "Are you finished with this mess?" he asks.
Matt Kaufler of Touchstone Value Opportunities Fund (CCEVX) will listen carefully for clues to whether credit quality is deteriorating. "To what extent [are] credit-quality concerns spreading above and beyond residential mortgages into other debt?" he asks.
2. Retail: Looking for signs about the rest of the year.
It's widely assumed that high gas prices are hurting retailers and other consumer discretionary firms. But much of consumer spending comes in the second half of the year, so investors will listen closely for clues about future spending.
Kaufler says the important information won't be in the second-quarter results, which are assumed to be bad, but in "what sort of tone management sets for the rest of the year." For example, he wonders what traffic patterns companies are seeing in their stores.
Many retailers, including Wal-Mart (WMT), the Gap (GPS), and Target (TGT), don't report results until August.
3. Focusing on the long term
These may be tough times, but Scott Armiger of Christiana Bank & Trust Company wants to hear executives thinking long term, planning three to five years ahead, when the slowdown presumably will be over.
For example, he says, perhaps they could be borrowing money now at low interest rates to prepare for future acquisitions. And with stocks in a bear market, "this is a great time to be picking up shares" through stock buyback programs, he adds.
4. Will GE bring good things to light?
General Electric (GE) reports earnings on July 11, and many fund managers say the conference call for the huge conglomerate is a don't-miss event.
GE's disappointing first-quarter report rattled the stock market, so expectations are low. "If [the news] is positive, the market could possibly rally on that news," says Michael Church, senior portfolio manager at Church Capital Management. If more negative news comes out of GE's finance unit, however, "the market is going to be spooked," he says.
Big industrial firms such as GE have profited from booming demand overseas. Kaufler says he'll listen to conference calls closely for any sign that the global economy is slowing.
5. Don't get spun
"I've always been cynical about these analyst calls," says Terry Morris, senior equity manager at National Penn Investors Trust. Executives invariably try to "put a positive spin on things," but Morris says he focuses mostly on the numbers that executives report, not the words they say.
If executives sound overly negative, on the other hand, they may be trying to manage expectations. Executives often walk a fine line in their quarterly conference calls: They want to impress investors and play up good news, but they don't want to raise expectations so high that those expectations can't be met.
"Apple (AAPL) has been very good at underpromising and overdelivering," Morris says. "That's part of the reason the stock has done so well." Apple's earnings arrive July 21.
6. Listen for tone
How do executives sound? "Sometimes your gut says these guys sound nervous," Church says. But, he adds, that's subjective and a tough basis on which to make investment decisions.
Kaufler advises investors to "attune your ears for candor or the lack of it." It makes a big difference if the management team is "speaking in specific terms" rather than being vague. A lack of candor may be a sign of problems at a company.
7. Listen to the analysts' questions
On most conference calls, only equity analysts at investment banks are allowed to question management. Because these analysts are often quite well-informed about a company, their questions can be as informative as the answers, Yared says.
But conference calls don't always create useful information for investors. "This is a very over-lawyered group of people," Yared says of executives. "Everyone is so cautious."
Still, earnings calls can be valuable to investors. Despite the caution and the cliches, the talk can still turn up plenty of surprises.