How to Analyse a Company’s Earning Results

Yesterday I focused on US politics. Today, let’s bring it back to Australia. I want to give you a read on how the local economy is travelling, using Woolworths’ annual profit result (announced yesterday) as guidance.

As you know, Woolworths [ASX:WOW] is a retail giant. It has a market capitalisation of nearly $40 billion. It has a dominant position in supermarkets, liquor, gaming and general merchandise.

In other words, when you spend money on day to day living, chances are you’re contributing to WOW’s bottom line.

In short, WOW’s results for the year to 30 June reflect an economy in reasonably good health. The company’s total sales growth from continuing operations came in at 3.4%. For comparison, the domestic economy’s nominal growth rate (that is, not adjusted for inflation) grew by 4.7% in the 12 months to 31 March, which is the latest data available.

In other words, it appears as though WOW didn’t fully take advantage of the domestic economy’s strong nominal growth rate.

For example, while the Australian food division (supermarkets) did pretty well, sales increased by 4.3%. Interestingly, year-on-year quarterly sales growth slowed to a low of 3.1% in the final quarter. This may indicate consumer belt tightening coming through from the housing slowdown.

The drinks division (Dan Murhpy’s) did well too, with sales in the year to 30 June growing 4.5%.

The drag came from Big W, which could only muster sales growth of 0.7%, and the hotels division, which grew revenues 3.7%.

Still it was a decent result and thanks to solid management, net profit after tax jumped 12.9%.

But here’s the thing. WOW’s share price dropped on the news.

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Check out the chart below…

MoneyMorning 21-08-18

Source: Bigcharts
[Click to open new window]

Woolworth’s full-year results disappoint investors

As you can see, the stock price peaked at $31.50 in mid-July. Since then it has declined, probably as news started to filter out that the results would be good, but not THAT good.

I don’t mean to say WOW leaks their earnings results. But the market is pretty smart. It usually works it out before the official news hits. As it turned out, the market was right. Once the results were out, the stock sold off further, as you can see by yesterday’s sharp decline.

In other words, while the result looked good on paper, the market expected better. Prior to yesterday’s release, WOW traded on a price-to-earnings ratio for FY18 of nearly 23 times, and 20.5 times expected earnings for FY19.

For a mature company, that’s expensive. Perhaps investors thought the supermarket division’s turnaround would take more market share off Coles? I’m not sure what the expectation was, but I do know that WOW didn’t deliver against market expectations.

How to decode a company’s earning results

Here’s the lesson for this reporting season. One of the quickest and easiest ways of working out whether a company’s earnings result was a ‘good’ one or not is to watch the share price’s reaction.

If a stock price falls on ‘good news’, then it wasn’t good enough. In most cases thereafter, the stock will usually go through a period of underperformance. If a stock price rallies on ‘bad news’, then you know it was already in the price. Often in this situation, you’ll see a stock continue to rally as investors move back in and take a position.

These ‘rules’ are loose and generally apply to the larger stocks (say the top 200) where lots of analyst coverage and investor interest exists. Still, it’s a good rule of thumb to follow if you’re trying to keep abreast of a sizable portfolio.

As far as WOW goes, the share price run is done for now. The market will worry about the slowdown in quarterly supermarket sales in the second half of the year, at least until the next quarterly update shows otherwise. Could it mean the economy is now slowing, after brisk growth at the start of the financial year?

When a stock trades on 20 times earnings, there is not much room for disappointment or uncertainty.

From a charting perspective, shareholders will want to see support hold around $29. A break below this increases the odds that prices could fall back to $26.

Fundamentally though, the economy remains in decent shape. Interest rates are low and a falling dollar provides additional support. While house prices are under pressure, rising bank shares tell you the falls (in aggregate) are only a minor correction and nothing to worry about.

Of course, that rosy scenario could all change in the blink of an eye. I’ve highlighted current US political issues as a potential future risk for markets. But for Australia, a more pressing issue is China.

Chinese stocks are at their lowest point since early 2016. They have given up nearly the entire bull market gains over the past two and a half years.

Tomorrow, I’ll take a closer look at what’s going on inside the Middle Kingdom, as well as giving you a way to profit from it all…

Regards,

Greg Canavan,
Editor, Crisis & Opportunity

PS: If you want to lay down a little money on the hottest corner of the ASX right now…but you don’t know your way around the small-cap sector…this report is for you. Get access now (free).


Greg Canavan is a Feature Editor at Money Morning and Head of Research at Fat Tail Investment Research.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand.

When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases.

Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis.

Read correctly, a chart contains all the information you need. It contains no opinions or emotion. Combine that with traditional stock analysis and you have a robust stock-selection strategy.

With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the basic, costly mistakes that most private investors do every time they buy a stock.

To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Money Morning here.

And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here.

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