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Earnings season is approaching – what to watch

We share what to look out for in the upcoming flurry of company results.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

There are certain times of year the share research team is busier than usual. The end of October is one of those times.

We’re expecting a flurry of updates from across the pond, as well as closer to home. Business news can become awash with stock market and company headlines and it can be hard to know where to look to find what really matters.

By no means an extensive list, we’ve tried to make that job a little easier. We explain what’s important to keep an eye on, and why it matters to investors, over the next couple of weeks.

This article isn’t personal advice, if you’re not sure if an investment’s right for you, seek advice. All investments fall as well as rise in value, so you could get back less than you invest.

Investing in individual companies isn't right for everyone. That's because it's higher risk, your investment depends on the fate of that company. If that company fails, you risk losing your whole investment. If you cannot afford to lose your investment, investing in a single company might not be right for you. You should make sure you understand the companies you're investing in and their specific risks. You should also make sure any shares you own are part of a diversified portfolio.

What’s going on?

The upcoming wave of results is the most important for a long time.

Fears of recession have been heightened – the IMF has downgraded its expectations for global growth next year. Looking specifically at the UK, mortgage rates have risen significantly because of the ongoing uncertainty. The average two-year fixed mortgage rate is about 6%.

This all boils down to one thing – uncertainty. Predicting the timing and extent of a recession is far from a perfect art. But company results offer an extra window into the world of consumer spending, industry costs and, most importantly, how management teams are assessing the outlook.

Lack of bad news could be good news in the US

US markets have been badly beaten up this year. The US is home to a lot of so-called ‘growth’ stocks, which are more highly valued than other companies in normal times. As interest rates have risen, these types of stocks have fallen out of favour. That’s because, at least in part, the higher risk associated with buying more ‘expensive’ companies isn’t as attractive when investors can get better rates on their savings accounts.

The US is also grappling with very high inflation – in fact it’s higher than expected, coming in at 8.2% at the last count.

Where uncertainty is so high, we could see disproportionate moves in the values of some of the bigger US companies that have until lately been deemed as growth stocks. This means a lack of bad news, or performance in-line with expectations, could be rewarded more than usual. By the same token, a misstep could be more severely punished.

The main thing to remember is not to be fooled by market movements – up or down. It’s important to look under the hood and really understand what’s happening before making snap decisions on if a company is well placed or in a tough spot.

Margins, margins & margins

Margins aren’t created equal. It’s important to compare a company’s margins with similar businesses – the profitability levels of a fashion retailer will be very different to a mining company.

We’re expecting to see margins come under pressure in the latest round of financial results. Soaring cost inflation and a hesitant consumer base don’t usually add up to mushrooming profitability.

What’s important to understand is why margin weakness is occurring.

For retailers, this is likely to be a result of reducing prices to encourage spending. This can be a successful tactic. But we’ll be looking out for how deep those price cuts are – dramatic swings in gross margins because of discounting suggests a company is finding it especially hard to stimulate sales. Is the company discounting more than peers? Is it out of line with its previous strategy? These are questions we’ll be asking.

Looking at operating margins, which also include the effect of more business costs like wages and energy, it’s important to understand how much room there is for margins to fall.

If a company has low-single-digit operating margins, a very sharp increase in the cost base or reduction in revenue could be very painful. We tend to prefer companies that have some breathing room.

Ultimately, this time around, margins are even more crucial to monitor than usual. They can help us understand if consumers are struggling to part with their cash, how resilient profits are, and the depths of the changes needed to keep things humming along.

There are various profitability metrics and the margin is just one – it’s expressed as a percentage of sales.

Look forwards not backwards

It’s always prudent to look at a company’s outlook statement, but now this is even more relevant. Things are changing quickly and what CEOs and CFOs have to say about their predictions for the coming quarter will carry more weight than average.

Outlook statements will also let us know which businesses have stronger earnings visibility. That’s just a jargony way of saying we’ll find out whose business models and products allow for more accurate predictions to be made about future demand and costs. These businesses are better placed to weather disruption.

Wishy-washy outlook statements or a total inability to predict what might be happening in the coming months suggests nervousness. Some companies might take the opportunity to lower expectations now and we will take a view as to how realistic those making positive noises actually are.

Putting money away for a rainy day

We’re not the only ones that hide money under the mattress when times are tough. Companies do it too.

When it comes to banks, they sometimes put provisions away when they predict people are going to default on their loan payments. These charges are known as ‘non-cash’ because they’re accounting charges rather than real money being squirreled away. We already know that so called ‘bad debts’ are on the rise, leading to concerns about banks’ willingness to lend.

When the UK-listed banks report results on the level of provisions put aside, as well as comments around loans and mortgage lending, it will give invaluable insight into the state of the economy. This is something not many other sectors can provide.

Similarly, impairment charges – which occur when a company downgrades the value of some of its assets – might well come through this earnings season.

Our attention again turns to retailers. Excess inventory leads to impairment charges in many cases. Having too much inventory can happen from operational blunders, like filling shops with undesirable clothes. Or it happens because people don’t want to spend their money as much as management predicted.

This latter scenario is the one we’re concerned about. Fashion retailers in the middle of the market, in terms of value, could be hit hard by slowing demand. Investors should have a keen eye on retailer’s results and whether they include inventory-value write-downs.

Key things to remember

No financial metrics should be looked at on their own. But it’s important to take stock of the upcoming earnings season. It will hold some very important insights into consumer and corporate resilience at both individual company and market level, as we navigate the next few months.

For those who don’t fancy doing all the work themselves, our team of dedicated equity analysts provide research on over 100 UK and international stocks.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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