Earnings season is a crucial period for investors, offering a wealth of information as companies disclose their quarterly financial performance.

However, it can also be a time of significant market volatility and confusion.

For all investors, distinguishing between the signal—meaningful, long-term insights—and the noise—short-term market reactions—is key to making informed decisions.

The degree of attention paid to earnings season can vary depending on whether an investor is an active equity investor or an index fund investor.

During my 30+ years as an investor, I have developed a healthy respect for the information in earnings reports without falling head over heels for every little nuance articulated by company management teams.

In my opinion, even index fund investors should pay attention to quarterly reports and assess how company fundamentals are evolving in the context of the overall economic backdrop.

Knowing what’s going on is important for all types of investors, but the degree of emphasis on quarterly reports varies by what type of investor you are.

In this note, I distinguish between active investors focused on stock picking and investors exclusively using index funds to gain exposure.

If You’re an Active Equity Investor

Active equity investors seek to outperform the market by selecting individual stocks based on detailed analysis.

For these investors, earnings season is an opportunity to reassess their holdings, identify new opportunities, and refine their investment strategies.

Here’s how active investors can focus on the signal:

Analysis Beyond EPS

Earnings per share (EPS) is a common headline number during earnings season, but active investors need to look beyond this single metric. They should delve into:

• Revenue Growth: Indicates the demand for a company's products or services.

• Profit Margins: Reflects operational efficiency and pricing power.

• Cash Flow: Provides insight into the company’s ability to generate cash from its operations, crucial for assessing financial health.

Assessing Company Fundamentals

Active investors should consider a company's competitive position, market share, and balance sheet strength. These factors help determine whether the company can sustain its growth and manage downturns.

Assessing Forward Guidance and Company-Specific Metrics

Forward guidance from management provides crucial insights into a company’s future plans and expected performance.

Every industry has its key metrics to assess future growth and profitability. For example, retail stores assess sales per square foot and new store openings. Banks, on the other hand, are very focused on net interest margins.

Warning: However, it's important for investors to approach forward guidance with caution. Management teams often have a vested interest in presenting a positive outlook and may exaggerate to boost stock prices or investor confidence.

Additionally, future projections are inherently uncertain, as they depend on numerous variables and market conditions that can change rapidly.

Avoiding Overreactions

Active investors must be cautious not to overreact to short-term market movements.

A single quarter’s results can be affected by one-off events that don’t necessarily reflect long-term trends. Patience and a long-term view are essential to avoid making hasty decisions based on incomplete information.

If You’re an Index Fund Investor

Index fund investors, on the other hand, typically adopt a passive investment strategy, aiming to match the performance of a specific market index.

For these investors, earnings season is less about individual company performance and more about understanding broader market trends.

Broad Market Exposure and Diversification

Index funds provide exposure to a wide range of companies, which naturally diversifies risk. This means that the impact of any single company’s earnings report is diluted, making the specifics of earnings season less critical for these investors.

Example: If a major component of the S&P 500 index misses earnings expectations, the impact on the overall index may be minimal due to the presence of other companies that may perform well.

Focus on Long-Term Trends

Index fund investors benefit from focusing on long-term market and economic trends rather than short-term fluctuations. For instance, understanding overall trends in consumer spending, technological innovation, or economic policy changes can be more relevant than individual earnings reports.

When to Pay Attention

Even index fund investors should occasionally pay attention during earnings season, especially if significant trends emerge that could affect the broader market:

Sector Performance: If multiple companies within a sector report similar issues, it might indicate a broader industry trend worth noting.

Emerging Themes: Companies will usually talk about their initiatives for growth and patterns will often appear. For example, the theme of onshoring supply chains became a topic of conversation during COVID. Similarly, the topic of artificial intelligence started with a few mega-cap stocks back in late 2022, and now virtually all management discussions address the topic.

Economic Indicators: Company earnings can sometimes provide insights into economic conditions, such as consumer confidence or business investment levels.

Asset Allocation Performance Review

High-Level Observations:

• All asset allocation portfolios we monitor are up year-to-date with higher-risk portfolios exhibiting commensurate higher returns.

• Conservative portfolios with a heavier allocation to bonds are in the process of recovering from the rise in interest rates starting in 2022.

• Over the last three years, the GF Low-Risk strategy is only up 1.2% on an annualized basis (before fees and transaction costs). Going back 5 years the annualized performance improves to 4.7%.

• Equity-heavy allocations have outperformed more conservative allocations thanks largely to the performance of US large-cap equities.

• The GF High-Risk strategy is up 3.3% on an annualized pre-cost basis over the last three years. Over the last 5 years, the strategy is up a respectable 7.9%.

• Commodities have given up a large part of their year-to-date gain as inflationary expectations have dropped considerably. The asset class is now up 4.8% for the year.

• Over the last month, Small Cap US Equities and Real Estate have significantly added to portfolio returns.

• Bonds have recently also picked up steam as expectations for looser monetary policy take hold among investors.

Weekly Performance Attribution

Long-Term Asset Allocation Portfolio Characteristics

Expected Returns: Expect slightly lower than normal equity and bond market returns given valuation conditions

Risk: Diversify with alternative assets, market volatility has been significantly below historical measures

Equity Risk: Asset allocation portfolios are dominated by equity market risk, no different from the past.

A Bit of Wisdom Never Hurts

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