Insight

THE biannual window into the performance of Australia's biggest companies otherwise known as the December half-profit reporting season has begun.

THE biannual window into the performance of Australia's biggest companies otherwise known as the December half-profit reporting season has begun.

If you want an insight into whether February 2012 represents a once-in-a-generation buying opportunity or the beginning of the global financial crisis Mark II, look out for two key phrases: "better than" or "worse than" expectations.

Profits matter, dividends matter, share buybacks matter. But share prices move most when something unexpected happens. Occasionally that might involve a takeover, or massive tax win, or a management overhaul. But mostly it happens when a company reveals a better-than or worse-than earnings figure.

Some market analysts spend their working days estimating how much money a company should make.

They inform professional investors, who buy or sell on that basis. When actual earnings don't match forecast earnings, share prices move.

The chart shows how much earnings expectations have changed over the past three months.

There's been a bunch of downgrades on materials companies and analysts now think profit will be 7.5 per cent less than they predicted three months ago. That's a big fall and reflects downgrades to earnings forecasts for BHP, Rio and other miners.

It's harder for analysts now because mining companies such as BHP Billiton and Rio Tinto are increasingly signing contracts based on spot prices or quarterly prices. Previously the price of iron ore and coal was set once a year and analysts only had to worry about changes in volume to calculate earnings. Now they also have to worry about changes in commodity prices.

The banks have also been downgraded in recent months. So, too, consumer-based stocks, such as Woolworths, but not as much as you might expect. Across the whole market, the figures is about minus 2.7 per cent. It means investors are more pessimistic about the state of Australia's big companies now than they were last October. The point is these expectations, rather than the actual profit figure, dictate whether a company has outperformed or underperformed, at least in the minds of professional investors.

And that's what drives the share price.

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