Every six months or so, I write about 'expectations season'.
I did just that, last week.
The short version: while everyone talks about 'earnings' as if the most recently reported profits (and their growth or decline) are the biggest impact on share prices, it's actually expectations:
First, not whether those profits grew or fell, but whether they were higher or lower than the market expected.
Then, it's about the company's stated expectations of the future, usually informed by the first 6 – 8 weeks of trading in the new financial year.
So yes, earnings matter.
Just not in the way many think.
But — and stick with me — it also goes one level deeper.
See, let's assume we're chatting about Woolworths Group Ltd (ASX: WOW).
And, because round numbers are easy, let's assume the share price is $40. (It's currently $40.01, but stick with me.)
Now given all of the expectations stuff, above, we can reasonably assume that $40 is the market's valuation, given what it thinks it knows.
And let's say Woolies reports earnings tomorrow morning.
If they're much better than expected (and if the outlook is good) shares might start trading at $42.
If they're worse (and the outlook is concerning) they might start trading at $38.
Now, other than how happy or unhappy you might be, respectively, did you notice there was a common word in both scenarios?
That's right, 'start'.
See that's the other thing. For all of it's faults, the ASX is pretty efficient.
You and I won't get a chance to buy at $40, in either scenario.
They'd close the day before earnings at $40.
And, in our example, the very first trade would be at $42 or $38.
There's no free lunch, here.
No-one gets to buy before the price rises. Or sell before it falls.
So what?
Well, nothing. And everything.
It means that there's little sense in rushing to judgement… or action.
The market has already 'priced in' the new news before a single share changes hands.
So 'What should investors think about the news' is a good question, but — if and when the market is efficient — also moot.
If $40 was fair yesterday, and $38 (or $42) is fair today, then you're richer or poorer, but there's not much in the way of 'so what'.
Unless…
See, that 'if', above, assuming the market is efficient. And paying attention.
And — and this is the big one for most investors — truly understanding the long term risks and opportunities for a business.
On Monday morning, brick company Brickworks Limited's (ASX: BKW) shares fell 5.5% in early trade because the company announced its NSW business (in particular) was struggling because of restrictions on construction activity, related to COVID rules.
Now, I don't know about you, but I find it hard to believe the market really had no idea of what was happening in NSW until the company's announcement this morning.
Now, sure, maybe it was worse than people were expecting.
Maybe.
But the market took $200 million off the company's market capitalisation, based on something it ought to have at least guessed.
Here's the other side, though:
This impact is going to be temporary.
Brickworks' market cap is about $3.8 billion.
If you had an asset worth that amount, and you thought it was worth $4 billion yesterday, would you really offer it for sale for $200 million less, today?
Based on some news that might have been expected.
That is almost certain to be transitory?
If so, can I ask that you run any potential fire sales by me, first, next time?
In the event, investors seem to have recovered from their shock.
Rather than down 5.5% as shares were, earlier, they're now down only 1.5%.
Someone owned shares yesterday, sold them for a 5.5% loss today, presumably in panic, only to see most of that gain erased by mid-afternoon.
Remember that 'efficient market' I mentioned?
Yeah… so much for that.
It's not just those short-term over-reactions, either.
Look at the share prices of retailers and travel companies, in March and April 2020.
The market lost its, well, stuff, driving prices down 60, 70, and 80% at some points.
Even the now re-loved Afterpay Ltd (ASX: APT) fell from $40 to $8 in the panic.
See, the 'efficient market' theory suggests that you can't beat the market, because everything we know is baked into share prices.
And, in that sense, the academics are right — we won't beat others by knowing more facts.
Nor can we trade faster than their supercomputers.
But we have two weapons at our disposal:
Our emotions, and our time horizon.
Yes, it can be hard to buy when the herd is selling. But if you can master it, well, you can take advantage of its pessimism — like in March 2020 across the market, or Brickworks, today.
And while others are focussed on today's earnings (or this week's or this month's), we have the luxury — should we choose it — of looking through these numbers and at the long term, instead.
Both, together, is even more powerful.
Was Brickworks long term value meaningfully and permanently impacted by the announcement of what we already knew, and only for a limited time?
I doubt it.
Were the travel and retail industries really dead and buried in 2020? We already know that answer.
So, yes, pay attention this earnings (or expectations) season.
But not to share prices.
Pay attention to company strategies. To growth. To trends. And to the people running your businesses.
And then, if the market offers you an opportunity, take it.
But, as Warren Buffett reminds us, we shouldn't be swayed by the market's moods.
We should remember that successful investors make the market their servant, not their master.
Fool on!
