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Today, we’re kicking off the third-quarter earnings season.
If you’re nervous about the latest round of reports, it’s natural.
We’re facing many global challenges, such as inflation, saber-rattling between the United States and China, surging energy commodity prices, and the tapering of the Fed balance sheet.
None appears to be generating more headlines than the ongoing supply chain crunch. So, if you passed a newsstand this weekend, you might have seen the harrowing cover of The Economist.
It’s an illustration of two barren grocery store shelves. All that remains is a single apple with the global map superimposed on its skin.
The title reads: “The shortage economy.”
As I’ve noted, the U.S. economy is facing significant delays in product shipments just months ahead of its busiest retail month (December).
Companies are scrambling to get everything from electronics to basic food staples on the shelves. This naturally will impact broad indicators like consumer sentiment and discretionary spending in the months ahead.
But let’s step back from this big macro headline from a globally focused magazine like The Economist.
Instead, let’s think about analyzing the impact of this and other trends at a microeconomic level. How does the supply chain crunch or changes in consumer spending impact your favorite stocks individually?
When we talk about macroeconomics, we are discussing the bigger and broader forces in the world that affect the financial growth of an economy. We talk about geopolitical tensions between China and the United States, and changes in energy policy or consumer spending.
This is the view of the markets from the clouds. Macroeconomic factors for a specific economy include inflation, income levels, the unemployment rate, and gross domestic product (GDP).
But microeconomics is a different beast. Various microeconomic factors impact almost every business in this economy.
This earnings season, you’ll hear companies release their earnings per share and revenue figures.
Then, more importantly, you’ll hear companies discuss their forward guidance. This guidance is based on macroeconomic conditions (consumer spending) as well as the microeconomic factors impacting their business.
Factors to Know When Buying and Selling Stocks
Microeconomic factors are not mutually exclusive. Instead, they are all intertwined and impact each other on a significant level. There is no specific starting point for analyzing the list of factors. So, let’s quickly dive into each one.
Every company in the S&P 500 has competition. Typically, we think of industry market share as a zero-sum game. Using the semiconductor market as an example, if Intel (INTC) makes more money this quarter, one might believe its competitor Advanced Micro Devices (AMD) will lose money.
The reality is that many competitors doing well at the same time indicates a healthy industry.
It’s important to listen for clues as to what is happening with a company’s competition, as it could be a bellwether of future events for its own performance.
Intel shares might fall one day if its competitor AMD announces it is facing severe supply problems, or one of its largest customers is struggling to deliver products to the United States. However, Intel might get a boost if AMD beats earnings and issues positive guidance.
Every company needs to attract customers. They need to not only build a loyal consumer base, but also keep new people coming in the door. That requires marketing spend, new advertising campaigns, and loyalty programs.
One of the most important indicators of future marketing spend is cash flow. So, companies currently facing supply chain crunches or high debt loads might not be able to expand their marketing budgets. Therefore, if a company announces that it might cut back on its ad spending, it may be concerned about its ability to gain market share or attract new customers. It could also be a sign that customers are not excited about the product (think New Coke).
Employee Costs and Management
Wage inflation is rising, and we remain locked in a very challenging job market. According to the latest Job Openings and Labor Turnover Survey (JOLTS), the labor market is surprisingly tight, and more than 10.9 million jobs are available in this economy.
Given current economic conditions, pay close attention to supply chain companies like United Parcel Service (UPS) or retailers like Macy’s (M) plans to hire ahead of the holiday season. If those numbers are weak, it could indicate that they expect weaker demand.
Finally, pay attention to their general hiring practices and retention. We want to know if a company is attracting talent and — more importantly — keeping talent.
Believe it or not, a company’s business image is critical and quantifiable. If a company gets into a public controversy, the value of the stock can and will fall. For example, consider recent cybersecurity attacks that impacted companies that own a lot of consumer data. Consider the cyber breaches at Target, Neiman Marcus, LinkedIn, Home Depot, and TJX Companies over the last decade.
These breaches represent a significant black mark on a company’s public profile. In the world of public perception, typically, no news is good news. But if you own a stock that is climbing out of a communications crisis, you’ll notice investor reaction to the company’s ability to improve its image.
From a supply chain perspective, look at the horrible story in March 2021 from The Guardian about Amazon delivery drivers experiencing 14-hour days with virtually no bathroom breaks. This story follows a series of exposés like one in The Verge from 2018 that discusses similar working conditions in Amazon warehouses. A company like Amazon facing negative public perception over working conditions or other matters might use earnings periods to address media stories or make policy changes.
Supply Chain and Supplier Relations
Inventory management is critical in business. Have too much supply, and you incur large storage costs and impact your suppliers negatively. Have too little supply, and you might run out of product in times of increasing demand. Logistics is a tricky business, and right now, we are in the latter situation. This earnings season, “supply chain challenges” will appear in the transcripts of countless earnings calls.
We know that McCormick (MKC) and Nike (NKE) are already facing extensive delays in bringing products to market. This will impact their forward guidance for the upcoming months in a profound manner. The great question is how much the market has already priced in this ongoing supply chain crunch.
What’s Up Next
Today, earnings season officially kicks off with reports from JPMorgan Chase (JPM), Delta Air Lines (DAL), and BlackRock (BLK). Every earnings season requires a plan, so I’ll break down a three-part strategy to help you sleep better at night in the weeks ahead.