What can we expect from the US earnings season?

The earnings season in the USA starts very shortly, much earlier than for South African Companies with a December year-end or, more rarely, half-year results.  Australian companies have 30 June as their year-end, so their December results are for six months.

In the USA results are provided quarterly, often to much fanfare by their media.  Coming in a rush, as they do, it is quite common for the headlines to be reduced to a number of over-simplified comments, such as ‘beat expectations’ – without saying whose expectations, what they were based on and, even more dangerous, how recently there were made!

There appears to be an assumption of a one-to-one and probably linear response by market participants to these announcements, as if that is what makes market prices.  Indeed, there may be an immediate response, generally reported as “due to”, “amid” and, when all else fails, “despite”.  Of course, longer term the analysis gets back to trends in earnings, rather than those of a single quarter and when serious company analysts have had time to digest the full scope of the announcements, rather than the ‘spin’ that is often found in the first paragraph.

What also often happens is that it is ‘first to market’, in terms of the commentators on TV, that sets the tone for reporting, discussion and sentiment.

So, ahead of the reports, let’s look at the companies in the Dow Jones Industrial index that, luckily, has only 30 constituents.  That should keep the discussion relatively short.  The DJI index is a curious index, in that it is calculated by simply adding up the prices of the 30 stocks – so much easier to do when it was introduced  in the early 1900s – rather than having to take the prices multiplied by the number of shares in issue to get the more familiar ‘market Capitalisation’ indices.

The five largest stocks (as at 11 January 2019, making up about one-third of the total contribution to the index) are:  Boeing, United Health, 3M, Macdonalds and Home Depot.  Whether that group is truly representative of USA ‘Industrials’ is debatable.  Those details usually come as a surprise – even to investment professionals who prefer to use the S&P500, where Alphabet, Amazon and Apple are right near the top.  Whether those truly represent USA ‘Industrials’ is also debatable.

Look at the following table:

The column headed TTM shows the earnings per share over the past (Trailing) twelve months and PETTM shows the price-earnings multiple (PE) using the current prices and the TTM figures.

Looking at this in isolation, one can see why, with these five all valued on close to 20 and higher times current earnings, many commentators say, “The market is expensive.”

But if we look for the ‘most expensive’ companies (based on PE) we find some staggering ones.  The top 5 are:

One explanation for this is that those are companies that have recently experienced difficulties – really? In the USA where things are going so well?  Clearly, they are being priced on the assumption that future earnings are expected to be higher.  How much higher?  By whom?  Why?  How sure is anyone that they will recover soon?

So let’s look at the analysts’ earnings expectations for these ten companies:

The second and third data columns show the Lowest and Highest analyst’s estimates of earnings per share: the column headed “Var’n” is simply the percentage of the high to the low.  A small percentage indicates a fair degree of agreement between the analysts, while a large percentage might need explanation as it would indicate significant disagreement between them.

In the top five, the analysts all believe that the earnings will increase in 2019 and there is a large degree of agreement.  The increases expected are extremely positive, especially of one uses the highest estimates.

In the bottom five, as suggested earlier, the analysts expect significant bounce-backs for all of the companies.

But looking for opportunity which may arise from better outcomes than the general market expectations, it is worth looking at where the largest difference between the high estimate and the low estimate are to be found.

An interesting group!  Clearly, different analysts, using different average oil price assumptions, will get different estimates for the earnings.  Apple is especially interesting, as it shows that there are definitely two schools of thought on the future of Apple as a company.

The column headed PEHi show what the future PE will be using today’s price if, indeed, the most optimistic analyst proves to be correct.  Note that none of these would look at all expensive (if . . . )

This exercise is surely more useful than many of the commentaries that you will see and hear in the next few weeks, about the ‘quarterly’ earnings and how they relate to ‘consensus’.

Liston Meintjes is a Portfolio Manager at NVest Securities in Johannesburg.