The Opportunity Of Earnings Season
The month of April has brought a collective thud for the stock market investor. Overall the S&P 500 Index finished positive for the month, up .38%, decreasing the year-to-date loss to -.38%. As we’ve discussed in prior newsletters, volatility has returned, driving the market down 3% during the month, only to rebound 6%+, then land at .38% to end the month. Essentially, a whole lot of something for nothing.
But, as most “investment professionals” will tell you, the stock market is forward looking (i.e., what is going to happen next to impact these businesses). And April is a great example of this as it is the first month companies begin to announce their first quarter financial results. An anticipated event by most but in reality, for the majority of companies it’s the same song and dance every year! And it is this that creates a fantastic opportunity for us… the long-term investor!
Here’s how it works for the majority of companies. (In parentheses is the stock price reaction):
· ABC Company will report its financial report,
· Wall Street analysts will compare this report to their estimates for ABC Company (price moves up or down based on earnings beat or miss),
· ABC Company management will hold their quarterly earnings call to discuss said financial report,
· Wall Street analysts ask a bunch of questions,
· ABC Company management gives a conservative outlook for the rest of the year (price goes down), and
· Lastly, if we are lucky, Wall Street analysts come out with new (many times) lower price targets for ABC Company.
This scenario plays out routinely for many companies. Many factors are in play here that all share a common characteristic… a short-term view. ABC Company management is giving guidance for the rest of the year and the Wall Street analysts are reacting to it. This is an event that takes place every quarter, but this specific one takes on even greater importance as it is a review of how the year started and how well management thinks the company will do for the rest of the year. Analysts and subsequently “Mr. Market” is going to react… and the opportunity presents itself!
Of course, not all companies fall into this category, but many do. And in 2018, where many stocks are priced to perfection, even a slight conservative forecast will drive a stock price down. See the above chart of 3M as an example. Here’s a stalwart company firing on all cylinders that lowered their earnings guidance by a mere 1.5% on 4/24/18. The result was a drop of 9% by the end of the week!?!?! Can you say “overreaction” to short-term news!
For us, if we own stock in a company, we’ve made this investment not based on the next 9 months, but multi-year expectations. If the short-term guidance does not change our long-term view on a company, we will naturally take advantage of Mr. Market’s opportunity and buy more. While April seemed boring from a performance standpoint, it is the beginning of a great period to do some bargain hunting!