4 Critical Things You Need to Watch as Earnings Season Begins

David Sterman
Posted: Jan 10, 2012 12:01 AM

We're entering one of the most important phases of the year for investors.

In the weeks ahead, many companies will set the tone for the remainder of 2012, laying out strategic goals along with sales and profit targets. For many companies, it will be the only time of the year they'll provide deep, forward-looking insights..

And though we all seem to be busier than ever, investors should carve out time to listen to conference calls of the companies on their watch list. There is simply no way to really understand a business -- and its prospects -- by only reading quarterly press releases.

Here are four key trends that may dominate the upcoming conference call season.

1. The (almighty) dollar
Thanks to the ongoing turmoil in Europe, the dollar has been bucking its long secular downward trend by rallying against the much-maligned euro. This is unfortunate for  many companies that reside in the S&P 500. The majority of them have considerable exposure to Europe, and a strong dollar hurts in two ways.

First, any profits made on the continent are worth less, since they are earned in euros. Second, U.S. firms become less competitive against their European peers when competing on a head-to-head basis. The dollar should eventually resume its steady downward decline, but look for companies such as Procter & Gamble (NYSE: PG) to dampen their near-term forecasts.

2.  A clean slate for bank stocks
Quarterly results -- and the forward view -- are getting a lot less noisy for major banks. The era of major write-downs due to delinquent loans is fading, and though economic activity remains too weak for banks to start discussing a much brighter outlook, the underlying body language should be healthy. Banks have strong balance sheets, and in many instances, trade for less than tangible book value. I still prefer Citigroup (NYSE: C) as the bank stock to own for 2012.

3.  Have profits peaked?
Outside of the financial services sector, which is coming off several years of depressed results, most other industries may be hard-pressed to boost profit margins and earnings per share (EPS). Friday's jobs report (Jan. 6), which showed a net gain of 200,000 new jobs, tells us the U.S. economy may be getting healthier in 2012.

But companies will likely respond to a more positive economic environment by adding to staff. Moreover, a strengthening economy tends to lead to price hikes for many of the key materials used in production. Taken together, these factors may cause expenses to rise at the same pace as revenue, implying limits to any further profit gains in 2012.

This shouldn't be a concern in the near-term. After a fairly solid third-quarter earnings season, analysts have done what they always do -- cut estimates for the next quarter. It's a fairly silly game in which analysts lower the bar, companies handily exceed this lowered bar, and everyone's happy. So in all likelihood, companies should again deliver estimate-topping results for the fourth quarter. As a quick recap, you can check out  the companies that handily exceeded the consensus profit forecast in the last quarter.

Just as Isaac Newton said that an object in motion tends to stay in motion, companies that beat estimates often continue to do so for a number of quarters.

4.  What about all that cash?
Companies have been building up cash balances to stand strong in the downturn. But these "rainy-day" funds are becoming a problem as the skies start to clear. It's getting harder to justify holdings millions, or even billions, in cash that earns almost no interest. So look for more discussions of stock buybacks, dividend hikes and acquisitions.

Here's a quick look
  at companies that can afford to sharply boost their dividends in 2012.
The table below highlights mid- and large-cap stocks that sported hefty levels of cash as of the end of the third quarter. If recent history is any guide, then this list will grow beyond the 12 you see here when fourth-quarter balance sheet figures are announced. 

Risks to Consider: The biggest risk for stocks in the coming earnings season remains focused on Europe. Companies are likely to cite tough operating conditions on the continent, but are expected to stress only a moderate impact on their forward outlooks. If these companies deliver especially scary commentary about European operating trends, then investors may again head for the exits.

Action to Take --> We finished 2011 on a reasonably positive note. The S&P 500 rose roughly 11% in the final quarter of the year, while economic indicators showed a more positive tone than had been expected. Friday's employment report, showing a solid 200,000 new jobs created in December, implies that 2012 may also start off on a positive note. Yet it's the management commentary in this upcoming earnings season that will really set the course for stocks for the rest of the year, which is why investors should be attentive in the weeks to come.

Disclosure: D. Sterman and/or StreetAuthority, LLC hold a position in PG, C.

This article originally appeared at www.streetauthority.com.