Surprise earnings

I have found that it’s often the events that we look forward to the least, that turn out surprisingly well and that many events that we have looked forward to for a very long time, often tend to disappoint us. At the beginning of 2018, there were great expectations and hopes that our local stock market would finally turn towards the more positive side after the FTSE/JSE All Share Index delivered only a very average performance of 8% growth per year up to the end of December 2017. Of course, this growth was largely due Naspers’s (27% p.a.) growth over the same period.

Along with the reporting of companies’ annual results come high investor expectations, and the same connection applies to analysts’ consensus forecasts, but some analysts can also miss the mark completely with their forecasts. With this in mind, I think its only appropriate that we look at why some analysts get it wrong, and also at the facts to our disposal at this time.

Shares have a tendency to react very positively following a better than expected financial results report (earnings growth), but also to react very negatively when weaker than expected results are reported. In negative cases, investor sentiment can influence share prices to such an extent that it can cause a complete collapse, just as it did in 2008.

It doesn’t matter if a company’s financial results are better compared to the prior reporting period. If it doesn’t at the very least reach the expected results, it may cause the share price to drop simply because the company didn’t quite live up to investors’ expectations. So clearly consensus forecasts are watched very closely and they can play a significant role in short term volatility in the market.

Although analysts are not fortune tellers, these types of surprise earnings can be seen as a benchmark for analysts’ faulty forecasts. Of course, there are analysts out there who deliver extremely accurate forecasts, but there will always be a few who are completely off-target. Some of the main reasons why they miss the mark at times include:

  1. It’s extremely difficult to make earnings forecasts. So many variables have to be considered that it makes it nearly impossible to deliver a completely accurate forecast.

  1. Analysts’ forecasts have a tendency to move closer together as time progresses, and the problem with that is that the ‘herd’ isn’t always moving in the right direction.

  1. Being over-optimistic.

Companies who soften the blow when bad news is reported. This is greatly due to mastering brilliant press conferences and other related meetings.

Table 1: Positive (green) and Negative (red) surprise earnings according to the latest financial reports (source: Thomson Reuters & PSG Wealth Old Oak)

I’m sure that everyone is aware of the fact now that the market didn’t turn around, and that it actually performed negatively (-6% since the beginning of 2018 up to the end of January 2019). Investors were left shocked and highly disappointed, because we were all looking forward to good news. But what was the reason for all of this negativity?

I created a diagram that shows us which companies on the FTSE/JSE Top40 either exceeded (green) or fell short (red) of analysts’ forecasts based on their latest reported annual results (source: Thomson Reuters), and all the red that showed up was kind of a dead giveaway. Only 29% of companies managed to exceed expectations based on their latest annual financial results, and then there are still those who haven’t yet reported, and although it may be green on paper for now, more recent published trading statements indicate that they didn’t manage to live up to consensus expectations.

Yes, I know these are historical figures and there’s nothing we can do about it now, but I will be keeping a very close eye on these surprise earnings for the next 6 months, because according to Thomson Reuters consensus forecasts, analysts expect shares (FTSE/JSE Top40 Index) to come to the party with a whopping 18% expected growth (excluding dividends) over the next 12 months. All we need now is for this diagram to show a lot more green and a lot less red.

Graph 1: FTSE/JSE Top40 Index 12-month consensus forecasts (source: Thomson Reuters & @SchalkLouw)

Don’t miss the party altogether just because you’re not looking forward to it. Just hang in there. Market conditions may still be uncomfortable, but investors should also guard against aggressive selling.

The opinions expressed in this blog are the opinions of the writer and not necessarily those of PSG. These opinions do not constitute advice.  This is intended as general information and does not form part of any financial, tax, legal or investment related advice. Although the utmost care has been taken in the research and preparation of this blog, no responsibility can be taken for actions taken based on the information contained in this blog. Since individual needs and risk profiles differ, it is always advisable to consult a qualified financial adviser before taking action.


Schalk Louw
As Portfolio Manager at PSG Wealth Old Oak and with over 20 years’ experience in the investment industry, Schalk has consistently delivered solid returns to his clients and has certainly become one of South Africa’s most well-known strategists. He started his career in 1994 at the stockbroking company, Huysamer Stals (later ABN Amro). He joined SMK Securities in 1997, (later became BoE Personal Stockbrokers) and was later appointed as director and branch manager. In 2001 he co-founded Contego Asset Management and managed the company as CEO up to March 2014, after which he joined PSG Wealth Old Oak. Schalk has also become a regular household name with investors, with his reports being published in many of the national press. He completed his MBA in 2008.

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