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3 Big Things to Watch This Earnings Season
October 11, 2021
It’s that time of year again. No, not Christmas but companies’ quarterly earnings season in the US. For investors, it’s going to be interesting to see which stocks can continue to “win” and see their businesses perform.
Now that uncertainty appears to be everywhere, it’s important to remember to focus on the longer term as investors and seek to buy the best companies in stock markets.
However, we should also be aware of what factors impact these companies.
With the US Federal Reserve tapering its bond-buying programme in a period of heightened inflation, there are also other issues to take note of.
With that in mind, here are three things every investor should be watching as companies start to report quarterly earnings this month.
1. Supply chains
It’s unlikely we’ve heard “supply chains” as much as we have in the past month or so. That’s because global supply chains are critical to many of the goods that we consume on a daily basis.
Shipping rates have exploded during the Covid-19 pandemic as e-commerce took off.
For example, while shipping costs between the US and China have fallen sharply recently, they’re still up to 10 times more expensive than they were pre-pandemic.
According to the South China Morning Post, transpacific freight costs in October still remain four times higher than the same period last year (even after a recent 30-50% drop).
The reasons for this are manifold. One, China has been closed off to the world due its’ “zero-Covid” policy and that has resulted in disruptions to port operations on the back of any virus outbreaks.
Second, power cuts in China – as the country moves towards trying to wean itself off fossil fuels – has led to a drop in output in the “world’s factory”.
So, what should investors be watching? Look for any management comments from retailers on how supply chains are impacting their upcoming holiday-period season (traditionally the busiest quarter for retailers).
Supply chain costs segue neatly into the second point of inflation. While policy makers aren’t too concerned on inflation pickup, branding the recent spike as “transitory”, it is causing markets to worry.
Everything from housing to cotton to labour is becoming more expensive in the world’s largest economy.
Labour shortages are particularly acute and evidence of the issue is being seen in the prevalence of “sign-on” bonuses and even cash incentives to show up for interviews.
For industries that involve “opening up” and face-to-face contact – such as leisure and hospitality – wage growth has been even higher (see chart below).
Sources: US Bureau of Labor Statistics, New York Times
This is perhaps an indication of peoples’ continued reluctance to take “riskier” jobs in the face of the ongoing Covid-19 pandemic.
So, for companies’ management teams, it will be interesting to see how they’ve navigated their cost structure in the most recent quarter and where they see it headed for the rest of the year and into 2022.
Beyond that, higher interest rates (on the back of persistently higher inflation) could see growth stocks continue to come under selling pressure due to investors having to “pay more” for those companies’ future cash flows.
Finally, the key for any earnings season will be individual company guidance. On a short-term basis, what management says about the firm’s outlook can move the share price substantially.
That’s because stock markets are essentially forward-looking. Share prices will normally react more to what management is saying about the outlook of the business rather than the numbers they’ve just released.
Investors will notice that even though many companies “beat” consensus expectations on its latest numbers, this can mean little in terms of the share price reaction given the business’s outlook is more important.
For example, in Zoom Video Communication Inc’s (NASDAQ: ZM) latest quarter, the communications provider beat earnings yet it guided for flat sequential growth in revenue for the third quarter.
That spooked markets and, as a result, its share price sold off to the tune of 17%. So, with companies across all sectors grappling with a post-Covid “normal”, it will pay to watch closely which sorts of companies are more bullish on the next six to 12 months.
Expect short-term volatility
While earnings season does come with a slew of data, it’s important to remind ourselves that this is just one part of running a business.
Earnings releases happen four times so we shouldn’t look at any particular quarter in isolation without considering how businesses have performed over the years.
This will give us a better gauge of their overall direction (and share price appreciation potential). Despite all that, it’s shaping up to be one of the most eventful earnings seasons in recent memory.
Disclaimer: ProsperUs Head of Content & Investment Lead Tim Phillips owns shares of Zoom Video Communications Inc.
Tim, based in Singapore but from Hong Kong, caught the investing bug as a teenager and is a passionate advocate of responsible long-term investing as a great way to build wealth.
He has worked in various content roles at Schroders and the Motley Fool, with a focus on Asian stocks, but believes in buying great businesses – wherever they may be.
In his spare time, Tim enjoys running after his two year-old son, playing football and practicing yoga.