Why earnings upgrades matter

Investors who focus on improving earnings outlooks give themselves far better odds than those trying to catch falling stocks.

Hi, it’s Callum Newman from Marcus Today.

This video is about a simple rule that can help with your trading or investing – however you approach the stock market. To explain it, let’s start with Rio Tinto (ASX: RIO).

In recent trade, Rio hit an all-time high. If you follow the news, you’ll know copper has gone on a major price breakout, moving into new all-time highs, while iron ore has held up better than expected. The market is positioning for Chinese stimulus as part of its next five-year plan, which is very important for Rio.

Rio has two main earnings divisions – copper and iron ore. Every time those two commodity prices go up, Rio Tinto makes more money. If you look at the chart, you can see the market is bidding on the stock very strongly. It can see improving commodity prices and a better outlook for the Chinese economy, and therefore for iron ore and copper.

The simple rule behind strong share prices

So why do I bring this up? Because it leads to a very simple rule you can apply to your trading.

This comes from a study done by fund manager Firetrail last year. They looked at 20 years of data on the ASX 200, trying to understand which stocks outperform and which don’t – and why. What they found was straightforward. Companies that outperform are those that upgrade their earnings or outlook. Companies that underperform are those that downgrade their earnings or outlook.

In the case of Rio Tinto, the market is becoming more excited by the outlook because of higher commodity prices and improving conditions in China. The share price reflects that.

When the outlook deteriorates

The opposite example is a stock called Bapcor (ASX: BAP), facing management issues and industry problems. Looking at a chart from 2022, you can see the share price moving into a clear downtrend. That’s the market pricing in a worsening outlook for that particular business over that period.

This reinforces the general rule from the Firetrail study. If you focus on stocks with an improving outlook, you give yourself much better odds of making money. It’s amazing how many people don’t do this. In the case of Bapcor, someone was buying that stock all the way down.

Part of what we do at Marcus Today is help you identify stocks most likely to upgrade their earnings or outlook, and benefit from a share price lift in response.