Cents and Sensibility


Saturday, May 12, 2001

Old-fashioned earnings
a good indicator

It seems logical to assume that those companies that actually earn money are good prospects for investors. But not everyone thinks that way.

Many people invested in the so-called "dot-com" stocks when they first came on the market and their stock prices took off. Even while that was happening, however, these companies were actually losing money, quarter after quarter. Yet, more investors swarmed to them, attracted by their impressive sales and fast-growing market. The great interest in these stocks drove their prices up.

When reality set in, and the high prices could not be sustained, many investors realized the importance of earnings when evaluating stock performance. Like the race between the tortoise and the hare, an approach that's slow and steady will often provide better results than one that's fast and erratic.

The dot-com example illustrates that earnings are important to a stock's success. But the issue is not clear-cut. When looking at a company's earnings, keep two things in mind:

>> Strong companies can show poor earnings results. Earnings can suffer from many factors: an economic slowdown, product difficulties, etc. For strong companies, problems like these may be temporary. You need the ability to look past a bad report and see a company for what it truly is.

>> The market may not immediately reward companies with strong earnings reports by buying its stock. Why? The market typically looks ahead at the factors that may be affecting next quarter's -- and next year's -- earnings. Are the company's products will-positioned? Does its management have a clear sense of where it wants to go? Looking at the bigger picture, is the Federal Reserve likely to cut interest rates? And will consumer spending remain strong?

These are the sort of questions that the market needs answered before it expresses its confidence in stocks, in the form of higher prices.

Nonetheless, you still need to look closely at a prospective stock's earnings. If they're weak, try to find out the cause. If earnings are strong, try to determine if they're going to stay that way.

Guy Steele is a financial planner and head
of the Pali Palms office of Edward Jones. Send
planning and investing questions to him at 970
N. Kalaheo Ave., Suite C-210, Kailua, HI, 96734,
or by email at:

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