How Hiring Trends Can Predict Earnings

The following originally appeared on Moneyball Economics. 

Earnings season is underway… and I still see earnings surprises coming.

I scope out a company’s hiring and operational spending to get a read on these companies.

Having worked in the corporate world, I can tell you for a fact that today’s hiring is tomorrow’s revenue and earnings. That is, companies hire today based on their expectations of future business activity. And I have good line-of-sight to their hiring and operating expenses (OPEX).

Moneyball models are able to forecast major inflection points where companies cut back their hiring/OPEX in advance of slowing sales. In essence, companies have held spending lower for longer. Not because revenues were falling. But because it led to margin expansion.

This makes our strategy simple.

A lot of companies are ramping up their spending. There is exactly one reason why companies hit the spending gas pedal: business is picking up.

When I see this, I will jump up and shout: go LONG. And with the market gung-ho, anyone flashing upside will get amply rewarded.

At the same time, I am going to be more cautious about calling for short positions. There’s few reasons companies ramp up spending (and it’s always positive), but there are many reasons why a company restrains spending – not all negative. For example, a merger or spin-out AA and Arconic Inc ARNC) is frequently accompanied by headcount rationalization and spending cuts. A false signal, if you will.

In general, I also expect some margin expansion for many industrial companies.

First, because I think costs have been cut and there has been some incremental uptick in demand. Second, because I think suppliers are enjoying some pricing power (they have been raising prices or at least cutting them more slowly).

I’m seeing this in the semiconductor space, for example. Inventories were cut so deep that mild restocking has enabled suppliers to charge better prices. It’s a short-term condition, but it still has positive upside impact.

In other words, it’s easier to find some margin expansion even if companies are only standing still.

KEY TAKEAWAY: My models have now been updated and can more accurately reflect trends and inflection points headed into earnings season. This is providing Moneyball Trader readers with plenty of opportunities that could reap massive gains.