Earnings season is a crucial time in the investing calendar and serious stockmarket investors should monitor the performance of each and every stock they hold – on top of scanning the market for potential buys. Investors tend to go into earnings season not exactly knowing that they should do. Sometimes stocks fall in price after reporting record profits, while others rise on sub-standard results.
This earnings season is critical considering the number of companies doing it tough in slowing business conditions.
Industrial stocks will be badly hit as earnings per share (EPS) is tipped to fall - the fourth straight year of negative growth. Resources stocks on the other hand are forecast to perform well, with earnings per share across the sector expected to be significantly higher due to strong commodities prices.
Investors need to aware of companies coming under stress due to the downturn in Europe, the UK and the US, the high Australian dollar (such as healthcare), limp consumer spending (such as consumer discretionary), and a cooling property market (building materials). Companies most vulnerable to the strong Aussie dollar include News Corporation, Paperlinx, Aristocrat Leisure, Incitec Pivot, CSR, Ansell and Resmed. And take note, many of the top 50 companies in Australia have overseas operations.
Investors should even be tentatively bearish towards resource stocks that are too highly leveraged and stocks experiencing margin pressure as labour costs rise. The market may punish resource stocks whose outlook statements reflect more subdued conditions, particularly vulnerable are those trading on high multiples.
Media companies, also, are feeling the pinch as advertising revenue slows. Ten Network is slashing 12% of its staff, or 180 jobs, to save money in anticipation of flat earnings growth this financial year. Profit warnings in the media sector have been few and far between, which opens the sector to volatility should earnings fail to live up to expectations. Fairfax and Seven West Media are vulnerable to further sell offs if earnings disappoint.
Although Australia celebrates its close links with fast-growing China, nonetheless, the domestic economy is facing similar growing pains to other developed nations. The Australian economy is coming off the back of a decade-long debt-fuelled property and consumption binge that led to record profits across almost every sector of the economy. Today, we face a period of de-leverage, where savings rates will grow, and consumers and businesses will take on less credit. The share prices of Aussie companies will begin to reflect a much less-spectacular future.
Hardy Aussie banks are not immune from the downturn either. Assistant governor of the Reserve Bank of Australia, Malcolm Edey, was reported as saying that Australian banks are unlikely to ever again enjoy “the days of consistent double-digit growth in lending we saw in the pre-crisis years”.
Eddy said: “That growth was driven in part by factors that can't be repeated – the deregulation of the financial system and the transition to low inflation…In the post-crisis environment, borrowers and investors are more cautious, both at home and abroad. That's likely to mean less demand for leverage and more reliance on equity funding, even when the economy itself is growing strongly.”
Bendigo Bank’s Managing Director Mike said that investors must think of banks more like utilities than growth stocks. Banks will deliver stable, but not spectacular growth, he said. Such changes in earnings expectations for the future will begin to be reflected in the price/earnings ratios of the banks. Investors, therefore, should be selective in the banks that they hold and ensure that they are not over exposed to the banking sector.
Insurers, too, are rumoured to struggle this reporting season as claims mount following floods, cyclones and the unprecedented number of unforeseen events. Investors dumped QBE's stock on Friday after learning its insurance profit fell 8% and the margin was cut 4.6% on record levels of large individual risk and catastrophe claims. The share price dumped 11% as a result.
During reporting season brokers look out for earnings surprises, where the earnings and/or sales reported are higher or lower than analysts’ predictions. When a company reports higher earnings than analysts’ forecasts, it can trigger an increase in the share price. Positive earnings surprises tend to occur when a company grows faster than its historical rate due to a turnaround or a new growth market.
With the exception of resources, we are likely to see more negative surprises than positive as companies adjust to significantly slower business conditions. Profit warnings prior to the start of the reporting season - flagged by the likes of David Jones – hints at some disappointing results over coming weeks. And in a jittery market, the smallest disappointment can result in a price sell off.
Due to the tendency of the investment community to reward companies that overshoot earnings expectations, companies prefer to surprise the market on the upside than downside; hence, the tendency of companies to report profit warnings before reporting season begins such as David Jones, Myer, Noni B and Premier Investments, the owner of Portmans and Just Jeans. All of these retailers have issued profit warnings over the last little while.
Other companies to issue profit warnings include oil refiner Caltex, insurance group QBE, engineering and construction group Clough, agribusiness Elders, and a whole host of others. Corporate governance rules require companies to immediately announce to the market once it’s known that earnings will be more than 15 per cent below market expectations.
On Friday, shares in Billabong International dropped 26% to the lowest level in a decade after the surfwear retailer reported a sharp 18.4% decline in profit from the prior year. Billabong anticipated 12 months ago that earnings growth rates would be in excess of 10 per cent from the current financial year. The guidance was falsely predicated upon a global recovery. Clearly, the result fell far short of expectations and the share price was punished severely.
Investors should keep a close eye on outlook statements of companies reporting as these offer the best glimpse of the road ahead. Some stocks with solid earnings could be sold off due to outlook statements that signal trouble ahead or slowing conditions.
However not all stocks will disappoint the market as well-run companies with key markets and products will continue to grow regardless of the economic climate. For instance, many analysts are tipping technology as a standout sector this reporting season. Consumer staples, utilities and healthcare, too, will no doubt fare well as a defensive play as investor rush to companies that can make money whatever the climate. Key stock picks within these sectors might provide a nice buffer over coming years.
Other investors are keen to pick up stocks with a positive future that have been recently dumped due to sharemarket jitters. Mining services companies, which have been outstanding performers over the recent past, have come off as bearishness sets in. However if the commodities super cycle does play out for the next twenty years, as some commentators predict (and what a devastating ecological result that’d be), then key mining services companies, and miners for that matter, will continue to reap gains. The key is to find those companies least exposed to any economic shocks, that are well diversified, and aren’t overly exposed to the fortunes of any single commodity. Keep in mind, too, that a prolonged downturn in the US and Europe will eventually hit China, resulting in a reduction of commodities demand. Reducing exposure to high-risk commodities plays might be a wise move earlier rather than later.
Investors looking for income can no longer rely on juicy cash rates of 6-7 per cent as the Reserve Bank of Australia contemplates reducing rates in line with sluggish growth. Term deposit rates have already fallen as a result. Investors should target sturdy dividend paying stocks with a history of consistently paying dividends. This is naturally a defensive strategy as dividend-paying stocks tend to be more established companies that are better able to withstand economic shocks.
Be careful, however, when choosing stocks on high dividend yield. A company with a falling share price will post a higher dividend yield than one whose share price is holding up. Although you ideally want to maximise your income, you want to avoid making capital losses on your investment.
Below is a list of companies reporting this week.
Monday, August 22
AMC - Amcor Ltd full year results
CGF - Challenger Ltd full year results
CTX - Caltex Australia Ltd first half results
NHF - NIB Holdings Ltd full year results
NPX - Nuplex Industries Ltd full year results
BSL - BlueScope Steel Ltd full year results
TWE - Treasury Wine Estates Ltd full year results
Tuesday, August 23
ORG - Origin Energy Ltd full year results
MGR - Mirvac Group full year results
SHL - Sonic Healthcare Ltd full year results
CMJ - Consolidated Media Holdings Ltd full year results
FGL - Foster's Group Ltd full year results
TTS - Tatts Group Ltd full year results
OSH - Oil Search Ltd first half results
EHL - Emeco Holdings Ltd full year results
Wednesday, August 24
BHP - BHP Billiton Ltd full year results
QAN - Qantas Airways Ltd full year results
SUN - Suncorp Group Ltd full year results
WOR - WorleyParsons Ltd full year results
AIO - Asciano Ltd full year results
DOW - Downer EDI Ltd full year results
APA - APA GROUP full year results
MOC - Mortgage Choice Ltd full year results
SXL - Southern Cross Media Group Ltd full year results
WOT - WOTIF.COM Holdings Ltd full year results
Thursday, August 25
WOW - Woolworths Ltd full year results
AGK - AGL Energy Ltd full year results
IFL - IOOF Ltd full year results
IAG - Insurance Australia Group Ltd full year results
ILU - Iluka Resources Ltd first half results
PPX - PaperlinX Ltd full year results
RHC - Ramsay Health Care Ltd full year results
PNA - PanAust Ltd first half results
CHC - Charter Hall Group full year results
MAP - MAp Group first half results
TOL - Toll Holdings Ltd full year results
VBA - Virgin Blue Holdings Ltd full year results
CWN - Crown Ltd full year results
TSE - Transfield Services Ltd full year results
ROC - Roc Oil first half results
Friday, August 26
PPT - Perpetual Ltd full year results
LLC - Lend Lease full year results
GPT - GPT Group first half results
FXJ - Fairfax Media Ltd full year results
ACR - Acrux Ltd full year results
SKI - Spark Infrastructure first half results
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