How to profit from the reporting season
Changes in earnings forecasts result in 75% of share price movements. How then should medium-to-long-term investors turn this information to their advantage?
Bank of America Merrill Lynch began researching global equities four years ago through the prism of changes in consensus forecasts versus movements in share prices. It coined the terms "contenders" and "defenders". Contenders enjoy rising profit expectations. However, the share price valuation of the company has not yet fully captured this improvement. The opposite applies to "defenders", whose share prices subsequently decline over time.
In this same vein of analysis, UBS has published a list of companies that could both surprise and disappoint investors, as revealed in the Australian Financial Review.
The potential "contenders" with better-than-expected results are CSL (ASX: CSL), Sonic Healthcare (ASX: SHL), Challenger (ASX: CGF), Nine Entertainment (ASX: NEC), Henderson Group (ASX: HGG) and Arrium (ASX: ARI).
The potential "defenders" with worse-than-expected results are Cochlear (ASX: COH), Carsales.com (ASX: CRZ), Trade Me Group (ASX: TME), Leighton Holdings (ASX: LEI) and Monadelphous Group (ASX: MND).
UBS strategist David Cassidy states that margins are forecast to improve significantly in the resource sector: "The big miners will be particularly interesting to watch, given the top line is still reasonably solid — hence cost-out could combine with decent revenue trends to produce surprisingly strong profits."
He thinks BHP Billiton (ASX: BHP) and Rio Tinto (ASX: RIO) have the potential to increase their payouts, but warns against expecting higher dividends this season in general.
For banks, including Westpac Banking Corporation (ASX: WBC), National Australia Bank (ASX: NAB) ANZ Bank (ASX: ANZ) and Commonwealth Bank (ASX: CBA), Mr. Cassidy considers payout ratios to be too high, which limits the chance for a positive dividend surprise.
Foolish takeaway
Avoiding torpedoes in your portfolio should be front-of-mind during earnings season. Recent examples that come to mind include QBE (ASX: QBE), Forge Group (ASX: FGE), Super Retail Group (ASX: SUL) and Treasury Wine Estates (ASX: TWE).
In my experience, anticipating profit releases is a fraught exercise. One should await the actual release. In the case of a "contender", the disadvantage lies in missing some of the initial upside (but outperformance typically continues over time), while the advantage is in avoiding torpedoes.
