As earnings season draws to a close, equity investors need to consider the bigger picture

Investors are looking at gloomy company results, but it’s critical that they look beyond quarterly numbers to gauge long-term value, says Giles Parkinson.

In their latest book, titled Radical Uncertainty (Radical uncertainty), economists John Kay and Mervyn King argue that in the midst of a crisis, policymakers would be inspired to step back and ask themselves “what is happening now?” This question, arguably not as straightforward as it sounds, can provide useful information on the dynamics of the moment, as well as the longer-term implications of current trends.

This is particularly useful advice for equity investors as companies release their results for the second quarter of 2020. After months of turmoil, the confusion begins to dissipate, exposing the damage caused by the slump inactivity. economy-related to containment. Refinitiv, a data provider, estimates that the results of the companies making up the S&P 500 Index fell 40% on average in the second quarter compared to the same period in 2019, which would represent the worst quarterly performance since the end of 20081. The picture is even bleaker in Europe, where forecasts point to a drop in the results of companies in the pan-European STOXX 600 index of no less than 60% between April and June 2.

Results publications provide an interesting insight into the performance of companies, even if some indicators are more relevant than others. By taking note of these results, investors must also ascertain the conditions under which they were published. In the current environment, investors should pay close attention to the operating leverage of companies and the state of their balance sheet, especially when there is a risk that the terms of debt contracts will be triggered by a further drop in numbers. business, forcing companies to raise capital.

PAt the same time, it’s important not to get distracted by short-term data, however bad it may be. The key to sustainable investing is to put these numbers in context and draw relevant conclusions about broader themes and trends.

Let’s go back to John Kay and Mervyn King’s question: “What’s going on right now? “. One of the peculiarities of the current crisis is that some quality companies have recorded a sharp drop in their turnover due to the containment measures, and this despite healthy balance sheets and sustainable economic models. Taken in isolation, the quarterly results of these companies are likely to give a misleading impression of their outlook.

Take the example of medical equipment manufacturers. At the height of the pandemic, most hospitals postponed urgent interventions, such as hip or knee replacements, to prioritize the care of patients with COVID-19, thus severely penalizing the turnover of manufacturers of prostheses. Johnson & Johnson, for example, saw a 35% drop in profits, due to the 33% drop3 sales of its “Medical equipment” division. This entity advanced the fall in the number of urgent interventions to justify its losses over the quarter. But there is no doubt that this activity will restart when the crisis, due to the decline in demand due to unmet medical needs, subsides.

In the discounted cash flow valuation model, it does not matter much that a company affected by the crisis returns to its usual flow/rate of turnover within 12 or 36 months, from the moment when she succeeds in getting back into working order. Investors should therefore be on the lookout for quality companies whose share prices have fallen excessively due to “panic selling”, a transitory event that caused poor performance in a single quarter.

However, while activity will resume normally in some areas, the coronavirus could lead to profound and lasting changes in others. The pandemic could precipitate sweeping changes in behavior, and businesses whose business requires bringing customers together in closed places – like pubs, restaurants, cinemas, and concert halls – face an uncertain future. In this context, one gets confused by asking whether an operator’s turnover has recently fallen by 60% or 90%; the right question to ask is to what extent people will want to go to these places in the long term.

Conversely, tech companies are growing stronger, taking advantage of the increased demand for video communications, online shopping, and streaming services during the pandemic. Microsoft and Ocado are among the companies that reported strong revenue growth in the second quarter.

While classic recessions tend to penalize the value of all companies, it turns out that the current crisis has, on the contrary, massively created value for certain technology companies: the Nasdaq composite index, focused on the technology sector, thus stood out with an increase of 15.5% between the 1er January and July 24. In contrast, the S&P 500 index fell 0.5% during the same period4.

Will the new behaviors turn into well-established habits?

The appreciation of technology stocks seems to reflect a lasting evolution in demand, teleworking, and online commerce being, in the wake of the COVID-19 crisis, called upon to play an even more important part in our lives. However, not all technology companies will be able to justify such a surge in their prices. Investors must use good judgment to be able to identify the real potential for value creation. The key question is to know to what extent new behaviors will turn into entrenched habits, and how much of the windfall of new customers can be retained.

It is often difficult to take a step back and consider the bigger picture in times of market volatility. Psychologists have proven that behavioral biases such as “short-termism” and loss aversion – a phenomenon that makes investors more easily sell assets that increase in value than those that decrease in value – are drivers important in the evolution of market prices at times like the current period. But investors who know how to keep their cool and assess the reality behind the numbers can always find attractive opportunities.


David Aurelio, “This Week in Earnings Q2 2020”, Refinitiv, July 24, 2020

Tajinder Dhillon, “STOXX 600 Earnings Outlook”, Refinitiv, July 21, 2020

“Quarterly results”, Johnson & Johnson

Bloomberg, as of July 24, 2020, excluding dividends

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