Earnings Momentum

What is Earnings Momentum?

Earnings momentum happens when corporate earnings per share (EPS) growth is accelerating or decelerating from the prior fiscal quarter or fiscal year. Earnings momentum typically coincides with accelerating revenues and expanding edges caused by increased sales, cost improvements, or overall market expansion.

Earnings momentum is additionally an investment strategy that attempts to invest in companies experiencing an increase in share price due to positive earnings momentum or growth in EPS.

Understanding Earnings Momentum

Due to the quarterly reporting system required by the Securities and Exchange Commission (SEC), most earnings momentum analysis will rely on quarterly data, as the smaller reporting period can highlight momentum earlier than yearly data.

Investors are generally watching out for positive earnings momentum, as it will normally propel a stock price higher over time. A company that has EPS of $1 for the current quarter, and had earnings of $0.50 for the same quarter one year prior, has seen a quarter-on-quarter EPS increase of 100%. That kind of growth might draw in a great deal of attention, especially assuming that the analysts believe, or guidance has been provided, that the company expects that type of growth to continue.

Numerous investors use price/earnings (P/E) ratios for assessing the price of stocks. When earnings accelerate rapidly, the price of a stock typically will accelerate too. When earnings are accelerating rapidly it is common to see high P/E ratios. While many stocks will trade at a 10 to 20 P/E, stocks with accelerating earnings momentum will often trade at 40, 100, or even 1,000 times earnings. This is because investors are planning ahead. Assuming the company continues to ratchet up its earnings, eventually those futures might legitimize the current high price and P/E multiple.

Then again, on the off chance that earnings momentum begins to falter, the price of the underlying stock might drop despite the way that earnings as a whole are as yet increasing. This is because investors have typically bid up the stock expecting the current earnings momentum to continue. On the off chance that investors are expecting half earnings growth each year over the next several years, and out of nowhere the company is just producing 20% earnings growth, that stock price may as yet decline or level off. This is because the future profitability of the company is presently reduced, or at least, will take them longer to reach the profitability levels investors were initially expecting.

Assuming a company is posting strong earnings momentum, and the stock isn't moving up, there are a few things that could be going on:

It's a decent deal the market hasn't noticed yet, and the price may before long beginning rising.
Investors don't believe the earnings acceleration or growth is sustainable, and therefore are utilizing the period of increased earnings to dump stock in anticipation of worse times ahead.
While earnings might be rising, they might be rising at a lower rate than before. So even however they are developing, they are decelerating, which might cause early investors and earnings acceleration investors to search for an exit (selling pressure).
The price has already been pushed too high to legitimize the current price, even assuming current earnings acceleration continues.

Therefore, earnings momentum doesn't generally mean the time has come to buy a stock. The market ought to be showing interest too by pushing the price up. On the off chance that the price is falling, that could be a warning sign, yet additionally an opportunity assuming that the strong earnings continue and the price has fallen to a more attractive price.

Example of Earnings Momentum

For example, assume a company had earnings per share of $1 last year, $0.50 the year prior, and $0.25 the year before that. Throughout the previous two years, the company has increased earnings by 100%. In the event that next year they increase earnings to $3, earnings momentum is accelerating up to 200%. In the event that this growth hasn't been already priced in, this could drive up the price of the stock.

Then again, earnings next year could end up being $1.25. Earnings actually increased by 25%, yet that is definitely less than the prior 100% increases. Earnings momentum is decelerating. Depending on whether investors are expecting this or not will impact how the stock price reacts. On the off chance that investors were expecting another 100% increase year, and on second thought it is just 25%, the stock price will likely fall. Then again, assuming investors are aware that earnings planned to decelerate, the stock price might continue to increase or level off.

How the stock price acts depends on the thing investors are anticipating, and how much the stock price moved prior to the earnings being released. In some cases, a stock might be bid up too aggressively, and afterward any indication of easing back or loss of momentum could be viewed as a negative. Then again, in the event that a stock price wasn't pushed up enough to legitimize an earnings increase, the stock price might shoot up when well earnings are released (whether accelerating or decelerating).

Highlights

Earnings momentum is when a company's earnings are increasing. Increasing earnings can be accelerating or decelerating.
Earnings momentum that is starting to decelerate doesn't generally mean the stock price will drop, however it does show that growth is at this point not quite as strong as it once was. During deceleration, earnings might in any case increase however at a decreasing rate.
Stocks with high earnings acceleration tend to trade at high P/E levels as investors bid up the price of the stock in anticipation of future company profits.
Some traders attempt to profit from the rising prices associated with earnings acceleration, and view earnings deceleration as a sign to potentially get out.