The upcoming earnings season – like drinking from a fire hose

Despite the best attempts of forecasters, it's impossible to accurately predict how the market will respond to a company’s earnings. However, Spatium Capital's Nicholas Quinn believes there is a better way to navigate this earnings season or any other disruptive market cycle. 
Nicholas Quinn

Spatium Capital

Twice a year, the earnings of various ASX-listed companies are reported. First, in February, providing a snapshot as at the end of December, and then again in August, following the Australian end of financial year on June 30th. Many see this as an opportunity to receive a health check on the current results and future trajectory of these listed companies. 

Despite the best attempts of forecasters, the unpredictable nature of how the market will respond to a company’s earnings leaves many working feverishly to calibrate their respective positions, especially when anomalies are rife. 

For example, it is not uncommon for a company’s stock price to increase when the market expects a greater decline in revenue than what is reported. Conversely, if a company does not achieve expected revenue targets (even if these revenues are positive), then it can result in a decline in the company’s ticker price as forecasters adjust their valuations.

It seems that recently, earnings season has become further complicated through the introduction of new and ‘undefined’ metrics that impact:

  1. the ‘top-line’, the company’s ability to drive increases or preserve its revenue stream within the marketplace;
  2. the ‘middle-line’, the company’s ability to effectively manage their costs, improve current processes to become more (cost) efficient, and manage its overall financial wellbeing (including debt obligations, etc) and;
  3. the famous ‘bottom-line’, the residual between how much money a company can bring in, and what it costs them to get there.

The ‘bottom-line’ may not always paint a clean picture, given ‘up-and-coming’ businesses often reinvest heavily in market share acquisition strategies (such as marketing, or developing new products). This subsequently drives up ‘middle-line’ costs with the hope of gaining future ‘top-line’ benefits. Without itemising each variable that sits within the top to bottom line segments, we trust the point has been made – earnings season is complex. More so now, it seems, with new environmental, social and governance (ESG) metric expectations.

Many businesses are now facing significant shareholder pressure to factor in ESG metrics. Whilst driving up middle line costs now, ESG so far appears to have significant customer and employee retention benefits, as well as being the public ‘right thing to do’. The cynic may challenge whether these programs are truly driven by ESG good or future ‘top-line’ benefit. Whereas the optimist might assert that whilst either motive could be true, greater ESG benefit cannot be a bad thing, irrespective of the method(s) used to get there. 

This discussion calls into question the purpose of a company (generally speaking, to operate in self-interest) vs. the operation of a government (establishing the rules that do not allow this self-interest to operate unfettered). It is the classic economics example of ‘who pays for the light bulbs in streetlamps?’ The cynic argues that through the creation of jobs and payment of various taxes, it is the company who pays for streetlamp bulbs. The optimist, true to character, would just be happy they don’t have to walk home in the dark.

If earnings season wasn’t already complex enough, the wider adoption of these new metrics can feel like trying to drink water from a fire hose. Like anything that is new, there will inevitably be kinks that need to be ironed out and parameters that need redefining. Perhaps the nirvana for these new metrics and their wide-scale adoption comes through regular policy and regulation revisions that encourage and guide companies to do what is considered socially better. Or maybe the onus is on the companies to willingly take on these new expectations from the community and thereby lobby the policymakers to formalise these shifts. 

Is only doing the right thing because you were told to do it enough in our customer-aware world? Either way, we suspect this debate is far from over and we watch with great intrigue how this may continue to impact future earnings seasons.

In conclusion, earnings season and finding the next best company is fraught with hurdles that are likely not made much easier with the level of information available. 

We’d argue that this is only going to become increasingly complex in an environment where pundits and analysts are doing their best to quantify and price-in a rise in interest rates, ongoing supply chain constraints and inflationary pressures that are seemingly going unchecked. 

Relying on strictly linear forms of measurement or analysis is likely to negate an investing edge and conversely, too much information is likely to saturate one’s bandwidth with little clarity on how to use it. We’d argue that the best way to navigate earnings season, or any other disruptive market cycle, is to not only remain convicted to one’s tried and tested investment thesis, but also keep half an ear to the ground for emerging trends to consider how these might need to be examined. 

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The Spatium Small Companies Fund (Fund) is an unregistered managed investment scheme in the form of an Australian unit trust. The Fund is only available to investors that are wholesale clients as defined in s761G of the Corporations Act 2001 (Cth). M&Q Capital Pty Ltd t/as Spatium Capital ACN 630 916 602 is the investment manager of the Fund (Investment Manager). The Investment Manager is a Corporate Authorised Representative (001279779) of D H Flinders Pty Ltd ACN 141 601 596 AFSL 353001. The Investment Manager's authority under its Corporate Authorised Representative Agreement with D H Flinders Pty Ltd is limited to general advice regarding the Fund only. Vasco Custodians Pty Ltd is the Trustee of the Fund and the issuer of its Information Memorandum. Unless specifically stated, public commentary does not constitute formal advice or commitment by any of the aforementioned parties. Nothing in this contribution is intended as personal financial product advice.

Nicholas Quinn
Spatium Capital

As co-founder and Director of Spatium Capital, Nick has an affinity for physics and mathematics whose principles have influenced the creation of the Fund’s investment strategy. As Director, Nick’s responsibilities are predominantly focused on...

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