With around 25 ASX 200 companies reporting full-year results this month, and 140 reporting half year results, reporting season will undoubtedly be a busy time for investors. Assuming a typical stock portfolio of 20 stocks, even just half an hour spent analysing each stock’s report represents more than a working day’s worth of analysis to complete. How then can busy investors make the most of their time to ensure they can get the best picture of the state of a company’s health in the minimum amount of time? Every investor has their own approach, but I’ve prepared some tips with input from Pie Funds and Cyan Investment Management to help navigate Livewire readers through this reporting season.
Part 1 – Pre-result preparation
Investors who only start thinking about results once they’re released are at a natural disadvantage to those who’ve appropriately prepared. Like most things in life, a little preparation beforehand can make your life much simpler on the day.
1. Know when your portfolio companies report. By setting out your own personal reporting season diary, you can be on top of each company’s results as they are released. This also helps to ensure you’ve got all the relevant information on hand when the announcement hits the ASX. As you’ll see in the link below, most companies tend to report towards the end of February, with weeks three and four being by far the busiest.
CommSec have prepared an excellent reporting season calendar covering most of the major stocks in the indexes: (VIEW LINK)
2. Know your own expectations. To avoid behavioural biases such as anchoring, groupthink, and loss avoidance bias, do this before you go looking for consensus views – in fact, I suggest not looking at the stock price at all at this stage. Try to estimate a range of acceptable values for the company’s key metrics, such as earnings per share, free cashflow per share, EBIT margin, and return on equity. Ask yourself “what would make me sell this stock?” and “what would make me buy more?”
3. Know others’ expectations. This one is a little more difficult; analyst forecasts are often used as a proxy for the markets’ expectations, but analysts are only part of the market. Other methods are more subjective, but to put it simply; higher prices equals higher expectations.
If you’re interested in taking a deep dive into this subject, Michael Mauboussin, Head of Global Financial Strategies at Credit Suisse, has written an excellent book on the subject called ‘Expectations Investing.' (VIEW LINK) The book explains how investors can use valuation techniques to understand the expectations implied in a company’s stock price.
Part 2 – Results announcement
Now for the most important part; the results themselves.
During this stage, you’ll need to take notes, so keep a pen and notepad, or a notepad program handy. As you notice anything out of the ordinary or unexpected (for example, a significant change in operating margins), take note of it to investigate what’s going on later.
1. The cashflow statement is the best place to start. ‘Cash is King’ holds true. The balance sheet is almost as important, though, as even the best business can be brought undone by a poor balance sheet. While it’s tempting to turn straight to the profit and loss statement, this is actually the last place to go to as it offers the least valuable information (for the same reasons as the headline earnings numbers). 2. Find answers to your questions. Earlier, I suggested keeping some notes of questions thrown up when reading the financial statements. Now is the time to find the answers to those questions. The media release is worth a quick look at this point. Other places you’ll find answers are the company presentation and the notes to the financial statements.
While Thornton L. O’Glove may not be a household name like Warren Buffett or George Soros, his book, ‘Quality of Earnings’, is on Bill Ackman’s list of ‘must-read’ books. If you’re looking to understand the information provided by companies in their statements, this provides an easy to understand guide: (VIEW LINK)
How Livewire contributors handle results
Dean Fergie from Cyan Investment Management (VIEW LINK) is primarily focused on "commercially proven businesses entering or enjoying a growth phase." Traditional metrics such as P/E ratio, dividend yield, and return on equity, are less relevant to them. Instead, they're more interested in cashflows and the company's cash position.
"Firstly, we take a hard look at the cash flow figures that are usually lifted from the quarterly cash flow report (Appendix 4C), particularly ‘Receipts from customers’ and net cash used in operating activities. Under ASX listing rules many unprofitable businesses are required to lodge 4C reports with the ASX. Most importantly these give us timely (every 3 months), transparent and regular insights into the most important metrics of a growing business, being sales and costs. These enable us to quickly gauge if a company is performing to our expectations.
Secondly, and particularly if the business is yet to be profitable, we pay close attention to the available cash and whether this provides ample runway for the company to reach profitability in the next 12-18 months. If this is not the case, then we would expect some type of capital raising event which is never great for a company’s near-term share price prospects.
Lastly, we take great interest in any outlook statements given by the company, that are usually contained at the end of any half-yearly earnings report. For us it’s often that case that we read the report backwards. To delve further into the commentary, we pay close attention to what was said in prior periods and if the current rhetoric matches with that and indeed, the notes we may have taken from meetings with the business in the past. Despite the extensive research, we conduct in trying to understand companies and industries, it is usually the case that we have to rely on management’s view on their prospects. If we don’t have faith if their outlook, then clearly these are business that we do not hold in our fund."
Mike Ross from Pie Funds (VIEW LINK) covers Software as a Service (SaaS) businesses; he says the three metrics they focus on when looking at SaaS businesses are; annualised revenue, revenue per user, and customer churn.
“SaaS businesses boast annuity-style, recurring revenues. If customer churn is low, these revenues should compound over time, delivering powerful growth. Many SaaS businesses in the small cap space are at an early, land-grab stage. Therefore, we look at annualised revenues as an indication of the businesses growth trajectory.
We also consider how much of the growth is being delivered from new customers versus the average revenue per customer. We want to see growth in average revenue per customer. A decline would be a cause for concern.
Many SaaS businesses boast low churn rates, so it is important to consider the stage of the company’s lifecycle. If the business is young, in high growth mode, then current churn may not be an indication of long-term churn and ultimately the durability of revenues. ,' where understanding the competitive landscape and drivers of customer decisions is critical.”
Part 3 – Post-reporting season review
Once all the results have come in, it’s a good opportunity to take a step back and review everything.
1. Where applicable, update your models and price targets. Now that your expectations have been updated with the latest results, you can begin to incorporate these into your investment decisions. Back in part one, I suggested taking note of what you’d need to see to make a buy or sell decision. Take a look back at these notes now and see if any of your conditions have been met.
2. Review your position sizing and portfolio positioning. Regardless of whether your portfolio companies have done well or poorly, it’s likely that there have been some significant share price moves throughout reporting season. You may find some undervalued opportunities that require topping up, it might be time to trim positions that have run hard, or it might be time to adjust your sector exposures.
3. Review your watchlist. While all this has been fun, it’s not over yet… Now it’s time to repeat parts two and three for your watchlist companies!
Patrick was one of Livewire’s first employees, joining in 2015 after nearly a decade working in insurance, superannuation, and retail banking. He is passionate about investing, with a particular interest in Australian small-caps.
Great work Patrick