Aaron M. Cooper, CFA, Director of Equity Research, October 16, 2012
It is often declared that a good time to buy a stock is when it’s on sale. But at Putnam, we believe that valuation — the relationship between price and earnings, or between price and free cash flow, to take two common examples that indicate a stock’s relative “cheapness” — is rarely all that matters. On the contrary, we believe that earnings drive stocks. Cheapness, that is, needs to be coupled with improvements in a firm’s business prospects — or a catalyst for realizing a higher valuation. For that reason, we spend the bulk of our time in Putnam Global Equity Research trying to get the earnings picture right.
Piecing together the earnings puzzle
The difficult question we spend our time on is: What drives earnings? This is where we need to focus on the one element or handful of elements that we believe will have the biggest impact on a company’s forward prospects. Consider the following categories and specific items that fundamental analysts typically investigate.
Any one of these areas could prove to be the most important point of focus, and more often than not, some combination of two to three of these items is what matters most.
Whatever the operative factor, being right about which one will be the main driver of future earnings gives the analyst a leg up on finding an earnings surprise, whether to the upside or downside, which can be the key to locating attractive return potential.