Expect Volatility and Opportunity This Reporting Season – Daniel Moore

Authors: Daniel Moore and Lucas Goode

With the next reporting season almost upon us, it can be tempting to get caught up in the noise, focus on the outgoing numbers, and miss the things that really matter when valuing companies.

Given the uncertain economic environment and the fact that investors are more concerned than usual about the near-term outlook for Australian shares, we expect to see some big moves across stocks this reporting season – some justified, some not.

Unusual earnings day swings have become increasingly common during the reporting season, in part due to technical reasons such as increased quantitative and algorithmic trading activity. We expect this trend to continue this month.

CHART: Day’s profits vs 30-day daily average, ASX200

CHART: ASX200 shares move >5% on earnings day

One thing we’ll certainly be watching closely is the strength of the consumer and how it impacts corporate profits and margins, particularly for domestic cyclicals. But there are a number of other factors we’ll be paying close attention to as we head into reporting season, as we outline below.

As consumers finally start to give in – what impact will that have on profits?

We’ve been talking for some time about how consumer spending is likely to slow as higher interest rates and inflation eat into disposable income – particularly among younger and lower-income earners and mortgage holders. So far, the consumer has been surprisingly resilient, but we’re starting to see signs that it’s coming under pressure, as the charts below show.

While this chart is from March, the latest feedback we’ve received from the firm suggests that spending has slowed even more in recent months. We expect this to be reflected in the results of some firms, particularly domestic cyclicals and discretionary retailers.

Immigration has been supporting demand and easing labor constraints for the past two years, but as immigration normalizes, that tailwind is fading. We’ll be watching not only the impact this has on revenues but also on the bottom line to see if companies have been increasing discounts to boost sales but then suffering lower profits and margins.

Towards the end of the fiscal year, we saw many companies reporting slower sales and lowering their profit forecasts – including JB Hi-Fi, Super Retail Group AND Bapkor – even some fast-food retailers are feeling the effects. With inflation still high and no sign of returning to target range anytime soon, cost pressures remain – whether it’s wages, electricity, insurance or rent. Which companies will be able to maintain their margins by passing these costs on to their customers, and which will not, will be a matter of great interest.

Dividends will likely be split along sector lines

We expect dividends to generally hold up quite well this reporting season, with a few exceptions. It’s important to remember that dividends are paid based on a company’s underlying profitability, not its share price.

The financial sector – particularly banks and insurers – is likely to pay healthy dividends. While many banks’ share prices are very high, they have strong balance sheets and capital positions, and bad debts appear to be under control. Insurance company margins also look healthy, as premium rates have risen and they themselves have not suffered excessively from the rise in claims. Higher interest rates have also boosted their investment income and therefore profits.

On the other hand, mining companies may struggle to maintain their recent dividend pattern. Iron ore companies in particular are struggling with lower iron ore prices and reduced demand due to a softer outlook in China.

Growth has outpaced value. Will this trend continue?

Many growth stocks have significantly outperformed value stocks this year, especially those related to AI and data centers. It will be interesting to see if these companies live up to investors’ high expectations, and if they don’t, whether they get penalized or not.

With the US reporting season almost over, we have seen the first signs of investor concern about the ability of highly valued AI companies to deliver higher returns in line with the increased capital they are investing in AI. High stock prices bring high expectations, and reporting season is always a reality check to see if business performance is in line with stock price performance. The AI ​​space has a long way to go, so it is unlikely that this reporting season will give us a clear answer either way.

Where we might see significant moves is in companies that don’t align with any exciting long-term growth themes and where high valuations don’t match higher earnings. For example, Australian banks have seen their share prices rise by about 40% since October, but their earnings are pretty flat. Share price movements following a bank report can be instructive.

Myopic focus on earnings likely to provide opportunities in small caps

Small caps have lagged the ASX100 significantly in 2022 and 2023 (by around 30% in total). While they have outperformed this year, small caps have yet to significantly close the gap in Australia.

That’s in stark contrast to the United States, where the smaller-cap Russell 2000 index outperformed the Nasdaq Composite by more than 10% in July as the market braced for imminent interest rate cuts.

Unfortunately for Australian small businesses (and mortgage holders!), given Australia’s persistently high inflation, we may not have achieved that goal yet.

Regardless, we currently see a lot of value being offered by small-cap industrial companies, both in absolute and relative terms.

The aforementioned high volatility of the reporting season is likely to be even more acute for smaller companies, due to lower liquidity and typically larger bumps and tilts. On earnings day, as well as in the weeks leading up to the reporting season, stocks often trade largely based on short-term (or even backwardation) earnings rather than on properly valuing fundamentals and long-term business opportunities.

Overreacting to sometimes temporary problems (both positive and negative) can create great opportunities for small-cap investors with a long-term perspective.

An example in our portfolio is a bus operator Kelsianwhich has been sold off significantly since its last earnings result due to temporarily higher labor costs due to a shortage of bus drivers and a delayed (since restarted) LNG project it services in North America. Neither of these issues is expected to materially impact the long-term value of the company’s infrastructure portfolio in our view, yet the stock has underperformed the Small Ordinaries by 26% since February.

We expect the August reporting season to bring plenty of buying opportunities like this one.

Given the uncertain economic outlook, expect volatility and opportunity

The domestic economy is currently fragile – inflation is out of control, consumers are under pressure and costs for businesses remain high.

This has created unprecedented uncertainty about companies’ short-term earnings and margins.

So far, the market has responded by pushing (and perhaps overpaying) companies that have a reputation for confidence in an increasingly narrow market segment.

We believe that many good companies with attractive, long-term growth prospects have been unfairly overlooked.

This reporting season will be interesting to see whether companies that have outperformed recently will live up to the high expectations built into their share prices, and vice versa. As always, we expect this reporting season to create both volatility and opportunities for long-term, value-focused investors who are good judges of a company’s intrinsic value.

This content first appeared in Livewire’s Season Reporting Guide, available at this link .