Don’t Let Alcoa Be Your Guide This Earnings Season

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The second-quarter earnings season is unofficially here. Earlier this week, Alcoa (NYSE:AA) announced its financial results for the most recent three-month period. The aluminum giant beat expectations, but its status as an economic bellwether and earnings indicator shouldn’t be given too much consideration.

Alcoa reported adjusted earnings of $76 million (7 cents per share), edging by Wall Street estimates calling for 6 cents per share. Revenue of $5.85 billion narrowly topped expectations of $5.83 billion.

Despite a beat on the top and bottom line, the results came under heavy scrutiny. Alcoa lost $119 million (11 cents per share) on an unadjusted basis, far worse than the net loss of $2 million (zero cents per share) a year earlier. Furthermore, expectations for the company have been declining all year, and the results only beat by one penny.

Investors should be careful about Alcoa’s standing as a leading indicator. Before the most recent quarterly results, the company reported earnings above the mean earnings per share estimate nine times out of the past 16 quarters. In those nine quarters, 73.6 percent of companies in the S&P 500 also reported earnings above EPS estimates on average, according to research by FactSet.

In the seven times that Alcoa came in below the mean earnings per share estimate, 72.6 percent of companies in the S&P 500 beat those estimates on average. The slight difference shows that Alcoa has “little predictive value in determining the earnings performance of the remaining companies in the index,” the FactSet report said.

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As seen in the chart above, in terms of performance relative to price, the stock market generally does better when Alcoa beats on earnings. The S&P 500 increased about 80 percent of the time over the next three months when Alcoa reported better-than-expected earnings in recent quarters. When Alcoa missed estimates, the S&P 500 climbed higher only about 50 percent of the time.

Looking ahead, expectations for the current earnings season are very low.

Coming into earnings season, 87 companies issued negative earnings per share guidance, compared to 21 companies that issued positive guidance. That is the worst level of companies issuing negative guidance since FactSet began tracking the data in 2006.

Most investors and traders will have their eye on the financial sector, which is expected to be one of the few bright spots this earnings season. On Friday, JPMorgan Chase & Co. (NYSE:JPM) and Wells Fargo & Co. (NYSE:WFC) were both cheered by investors for positive reports.

Investors set on betting the earnings season on a single stock may want to pay closer attention to International Business Machines (NYSE:IBM). Bespoke Investment Group looked at every stock in the S&P 500 and how they correlated with earnings season, and the computer giant had the highest correlation.

When IBM beats earnings estimates, the S&P 500 trades higher 80 percent of the time over the next five weeks. When IBM misses estimates, the S&P 500 trades lower 75 percent of the time, serving as a much better indicator than Alcoa. Either way, the low expectations this earnings season should soften any weakness in the market.

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