Earnings Headlines – What Do They Mean?

Categories: Drivers of Value
Brian Langenberg, CFA

As I schlep through my 75th or so earnings season certain things have changed – and for the better – the ease with which we can obtain data and basic information online, dramatically improved corporate disclosure and the ability to leverage information tools and processes allow us to more easily map out relationships and trends. For an experienced analyst the basic task of analyzing companies and industries has become easier.

Everybody else has access to similar, and sometimes better, resources and thus an even greater emphasis, and need, to not only anticipate results well before the report date (the traditional source of alpha) but also to break down, interpret, and leverage details on the report date with what are known as laterals.

Some things remain the same – like the utter uselessness of headline EPS results. We observe stock price versus market at 10:00AM EST because 30 minutes after the market open is the ideal time to measure initial market reaction). The first week of 3Q13 reporting season we focused on 13 companies – of which 3 were in line (within 2% of published consensus) and 10 had beats or misses that were significant (+/- 2% or more). In other words – it was almost a crapshoot.

Dover, for example, delivered a 4% EPS beat and fell (3) points relative to the market.  Conversely three other companies showed “misses” and rose including GE, GWW and TXT.

Perhaps revenue surprise mattered? It isn’t obvious. In fact the stocks of two companies – Grainger (GWW) and Hubbell (HUBB) – rose 3 points versus the market despite missing published revenue forecasts.

Six companies missed consensus revenue by 2 points or more – of which 2 had positive stock price reactions.

So what is it?  Depends.  Stocks embed an expected view of a companies future cash flows at all times.  That view may end up being right, on target, completely wrong and in retrospect later on sometimes outright delusional.  In each case, the market reaction in a stock can represent a signal and the then questions are a) what is the message behind the stock price change, b) is that message delivering information or noise and c) is there a way to transmit the information once we’ve identified it into a profitable trade or avoidance of loss?

Looking at the first week results of our focus companies a couple of things stand out:

  • Three high quality companies traded down – URI, HON, DOV shares traded off after delivering in line or better results and despite (or because of) revenue glitches that will flow back through later.
  • Danaher was up 4 points versus market on only a “slight” beat.  Investors were concerned about slow industrial markets but the largest segment – Life Sciences – continued to deliver stronger revenue growth.

If revenue and EPS are not the automatic drivers, then what is?  IR and PH were up strong and delivered beats – but so did Dover (DOV).

So what is the difference?  Remember – a quarterly earnings report is a snapshot of 90 days – the stock price is the market’s assessment of the future.

In our view – the market quickly priced in the most important information in the earnings releases of these companies – the future – as evidenced by new orders (equipment only for GE).  GE, PH, and IR all sported accelerating orders and for PH and IR in particular for the second straight quarter.

Punch line – it isn’t about the headline but what is underneath the hood! 

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