28 Jul What to look out for during the corporate results season!

We are about to enter the most important period for most of Australia’s listed companies – the full year corporate earnings season.

Given how much economic uncertainty is out there due to the pandemic, the one thing we can all count is share price volatility.

So, let’s examine a few of the issues that are important to share investors and what will move the share prices –

1. Expectations – By the time earnings are reported the market has already baked in some expectations of what the results will be. This means the share price has already moved in a direction up or down that reflects the market’s earnings expectations.

Let’s take last week’s reaction to the major US tech companies that reported as an indicator of what can happen. By most measures these companies announced excellent revenue and earnings numbers, yet all the share prices fell. Netflix fell on lower subscriber forecasts for the up-coming quarter; Microsoft’s excellent results were also offset by  lower expectations for the next quarter; Intel’s delay of its latest generation  7- nanometre chip was enough to send the share price down 16% and despite Tesla’s super profit, the shares fell more than 15%. No surprise there given the share price had more more than tripled off the March 2020 low on an expectation that this fourth quarter GAAP profit would make Tesla eligible for the S&P 500 index.

The US tech companies to date have been a classic sell the result example, because so much good news was already discounted in the share prices.

The share industry has an expression “buy the rumour, sell the fact”. The same can apply to the corporate earnings results. Conversely, those companies that actually surprise with the better than expected results or earnings outlook will be rewarded normally, with a higher share price.

Every reporting season share prices can move sharply around the announcement as traders and investors react to not only the reported past performance (was it better or worse than expected?) as well as any indications of future earnings, by way of the company’s guidance.

There remains so much uncertainty around how the Australian economy will perform in the second half of 2020 as COVID-19 continues to hamper economic activity in the two major states, Victoria and NSW. Sustained but lower levels of. government fiscal support (job keeper & seeker) may also put a drag on any recovery.

It is more likely than not that this August will exhibit a higher range of corporate results than usual. There is a large divergence between how sectors and companies have been impacted by the health crisis. Given the economic challenges and uncertainty any guidance from the companies will most likely be light on detail to conservative.

2.  Margins, dividends and capital strength – This reporting season will be a show and tell not seen since the GFC and some results could prove to be historically shocking. A number of companies in vulnerable and heavily affected sectors such as oil, gas and real estate have already generated asset write downs over $11 billion according to the AFR. Analysts are rightly questioning whether these write – downs are purely COVID driven or an indicator of a secular downturn i.e. the move away from fossil fuels and the shift from bricks and mortar retail.

All eyes will be on not only the top line revenue growth, but how margins faired. An example is Altium that has some analysts questioning whether margins have come under pressure as prices were dropped to maintain market share. Altium won’t be alone in trying to maintain sales at the expense of profitability.

Investors will also be keen to ascertain how robust cashflows are to support dividend payments and the extent to which balance sheets have come under pressure. Commonwealth Bank will be most interesting. They report on August 12 and analysts will be given an indication of the potential extent of future loan losses, balance sheet strength and what dividends are viable going forward.

Although, many companies have already come to the market to raise funds, including Cochlear, Afterpay, Ramsay, Webjet to name just a few, analysts will also be looking to identify who may need to raise capital going forward.

Some companies have also been the beneficiary of what could be termed positive COVID impacts. In the US tech sector, it is estimated in some cases, revenues have been pulled forward by as much as 2 years in the e-commerce space according to a report by Morgan Stanley “Emerging themes in life after COVID”, July 21.

Similar trends have been indicated domestically for the stay at home beneficiaries with an e-commerce slant. Analysts will be looking for any trends to confirm whether the positive impacts can be maintained, particularly in the retail work from home space, such as Temple and Webster, JB HiFi, Coles and Wesfarmers’ Officeworks and Bunnings to name a few. The BNPL (buy now, pay later) shares have also been beneficiaries from the stimulus packages to date and the stay at home economy.

3.  Share price targets will change – As the analysts go to work, assessing not only the past but future earnings and dividend estimates, it is only prudent to accept that the future 12- month share price targets will change, i.e. move up or down.

History has shown a strong correlation between share price targets and the actual share price. It is unrealistic to expect those shares who experience a downgrade in the recommendation (i.e. from buy to sell or overweight to underweight) will not also experience a downgrade in the share price target (based on lower earnings estimates). The opposite will apply to upgrades. Although as we have seen in the US market, some shares have already discounted a lot of future earnings growth.

CSL maybe a case in point. Debate continues over the effect of the pandemic on plasma collection and pricing. The bears are selling the stock to rotate into cheaper shares. The optimists remain confident this bio-tech giant will maintain earnings growth to support the higher share price valuation (currently 38.7x 2021 earnings at $275). All we be revealed on August 19.

4. Don’t be afraid to sell the losers and switch the capital to the winners – Reporting season is an excellent time for investors to reassess their portfolios.

I think it’s fair to say there will be a lot of share price volatility. However, it is always worth waiting to see how the analysts assess the results. It is not uncommon for the traders or the algorithmic funds to sell shares on a shoot now ask questions later scenario. Relying on just a profit number or the word “downgrade” as a full indication for the future may not explain the situation accurately or in its entirety. For example, I have seen shares fall sharply after a result only to see them climb during the company results conference call.

For those of you who have the time and the inclination, listening to the conference calls on the earnings results is a great opportunity to hear management and obtain a better understanding of the business and the future prospects. The calls are normally recorded and uploaded onto the investor relations page of the company’s website.

I was reminded again this week how lucky retail share investors are in this day and age. With technology now available to provide so much real time and up to date information, facts can be gleaned at the same speed as the professionals.

So, as we move through August, as always be alert and hopefully not alarmed, do your homework and don’t be afraid to take losses and move to those quality shares with good earnings potential at a reasonable price.

This was written on Monday July 27 and represents only the views of Danielle Ecuyer, Author of Shareplicity. The Author holds or has held some of the shares discussed in her SMSF. Please read the disclaimer.

DISCLAIMER – Shareplicity offers information that is only general in nature. It does not take into account your personal financial situation, needs or objectives. Nor does it take into account the financial needs of any specific person. You should consider your own personal financial situation and needs or seek financial advice before making any decisions based on this information.