Alcoa (AA) - the Expectations Game

Submitted By Trader Mark
Alcoa (AA) earnings are the traditional kick off of every quarterly ear nings season. I don't really follow this name much simply because, while it's a basic material, aluminum is not exactly my favorite. But I'd like to show readers the reality behind the numbers, while the seals on CNBC were clapping and hooting and hollering about the "beat". I'd also like to show you a trend you will be seeing this earnings season, and the ones coming - higher input costs. And squeezed profit margins - we've been warning about this "era" coming since last summer. It's now here.

First to the "great news" - Alcoa "beat" estimates - 66 cents versus 65 cents. So the seals cheer "better than expected". It's a joke. 90 days ago Alcoa was expected to do 77 cents, 60 days ago that was lowered to 75 cents, 30 days ago it was lowered to 73 cents, and JUST A WEEK AGO it was 68 cents. So they would of missed ALL these estimates. Only in the past few days (by miracle - not) the analysts were "guided" to push their numbers to 65 cents, and TA DA - we can have the seals crying with joy over the "better than expected" number. YEE HAW Cowboy.

Other reality checks?

Soaring energy costs and inflation in raw materials have eaten away at Alcoa's profits in recent quarters. "The energy situation along with the inflationary pressures on many materials has increased the cost of aluminum refining and aluminum smelting by 20 to 35 percent between 2005 and 2007, and we would expect a similar rate increase this year," Chief Executive Klaus Kleinfeld said on a conference call.
Alcoa Inc.'s second-quarter earnings fell nearly 24 percent - Net earnings were $546 million, or 66 cents per share, compared with $715 million, or 81 cents per share, in the same quarter last year, the company said.

So cost inflation is eating away their profit margin - and their profits are falling by a quarter year over year. A picture of health! Better than expected!

I cannot stress how you, as an investor, must read past the headlines. I do realize (and it drives me crazy) that a lot of people only read the headline and like lemmings a horde of buying orders comes in as long as Reuters says "beat expectations" - that's the "game" - and we are the guilty party as investors for creating this - it's all about "beating the numbers" - nothing long term matters. Everyone sits on their online brokerage account waiting for that press release at 4:10 PM, with the "analysts estimates" mesmerized and ready to hit buy within 9 milliseconds of the headline crossing the wire if the "number is beat". Or vice versa if not.

So companies have to play along - CEOs pull out all the stops to make sure they don't disappoint on a 90 day rolling basis (90 days means nothing other than on Wall Street - it is a very short amount of time to judge a business). Stocks move many times up 20% or down 20% simply on that "magic headline". It is a sad state but that's what "earnings season" has become. And this is why (for newer readers) you will see me cut back on almost every position going into its earnings - it's a gamble. And it's not even a gamble that makes sense - companies skyrocket on nothing more than currency gains or "1x adjustments" that mean nothing to their long term business, while other companies get smashed for "spending on Research & Development" or "guiding for 68% growth when expectations were for 72%". And just like that, a real fundamental story can implode in your face to the tune of 25-30% in after hours, for no good reason. Not worth the risk.

So the headline we all wake up to today is Alcoa is a beast, and its shares were up 5% early today- they beat their number; Fast Money traders rejoice. The reality is, this is a company that is not doing well - in my eyes. Expect a lot more charades like this, in this - and every earnings season. The only positive is sometimes you can pick up good companies the market has smashed in the mouth because the "headline" was not what the lemmings were hoping for. But that's a hollow victory when every day in earnings seasion is a literal mine you could be stepping on if the "headline" is not what the lemmings want.

Short lemmings

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