The reporting season can be a time of significant volatility as our companies lay bare the fruits of their labour while analysts pick apart the numbers. The earnings announcements released in August are particularly important as for most companies, it is their annual 30 June books close date.
Historically, the month of August is a good time to be in stocks, though it has had periods of significant negative performance. Since 1987, the market has enjoyed generally positive months with close to two out of three ending in the green, enjoying a median return of 0.88%.
Source: Lincoln Stock Doctor
At Lincoln Indicators we remain optimistic for the financial year ahead
We are in an environment where corporate earnings are still expected to be strong with earnings growth expectations in FY20 expected to be about 12%. Further, with interest rates at historical lows not only do businesses benefit, but many term-deposit evacuees and other holders of cash will be lured to the strong dividend returns and franking credits. Finally, positive and accommodative economic policies are in place as central bank intervenes in the form of quantitative easing to help stimulate the economy and hence stock prices.
There are however, rising risks, particularly as this upcoming reporting season sees our market return to levels not seen since the all-time high of 2007. There have also been an unprecedented number of earnings downgrades during confession season with an estimated 250 companies downgrading guidance from previously stated ranges. Further, a slowing global economy, uncertainty around trade wars, and high levels of debt, coupled with high valuations has meant many investors are cautious in the lead up to the August reporting season.
Yet now they sit atop a pile of non-interest-bearing cash, with sweaty palms as markets continue to rise and growing fear of missing out starts to impact the psyche.
So what options are there for those eager deploy to capital now within the potential uncertainty that a reporting season can bring?
- Often investors think too deeply about making an investment decision, which can result in procrastination and ultimately neglect. Therefore, should a stock meet your criteria for entry and it is going to be one of say 15-20 stocks in your naturally diversified portfolio, then an opportunist who has conviction in the business may consider acquiring the company now. Maintaining a spread of businesses ensures the relative impact of any fall in price of a single stock will not markedly change the overall performance of the portfolio. That said, if the stock you are looking at is currently trading at a premium to its valuation after a strong run up, then it may be prudent to implement a stop loss level to protect your capital.
- If you are not so confident in the calibre of what you are looking to invest in, then perhaps you may consider only those companies that have had positive announcements in the lead up to their report in the form of a profit upgrade or solid operations update. Positive announcements will help support the view that the business is indeed quality and therefore any current view that the market is attributing to the business is indeed justified. Further to this, and with confession season behind us, it is also a case of ‘no news is good news’ given there is now less likely to be any new unexpected active risks emerge that derails the future fundamental strength of the business.
- If you are a risk adverse investor where the potential for downside volatility terrifies you, then waiting for the next report to confirm the fundamental qualities of the business are reconfirmed is prudent. This form of insurance will ensure you miss any initial savage shock should it occur. Of course, it may also mean that you miss out on a real pop in the event of positive news, but that is the cost of insuring you do not risk your capital when companies do not meet expectations.
- If you want to be cautious but don’t want to wait too long, then another option is to take an initial part exposure and dollar cost average into the stock. Dollar cost averaging helps avoid buying into a great stock at the wrong time by spreading the purchase out over several transactions to smooth out price fluctuations. You may therefore consider buying a parcel before the report and then once you have analysed the result you can choose to take a full position. Should it disappoint it then sell your reduced position with a smaller hit than potentially would have been the case.
ELIO D’AMATO (@Elio_DAmato)
Elio D’Amato is the Executive Director at Lincoln indicators, a leading boutique fund manager and creator of Stock Doctor the complete share market research platform. www.lincolnindicators.com.au
Lincoln, Lincoln Financial Group Pty Ltd and directors, employees and/or associates of these entities may hold interests in ASX listed companies. This position is disclosed within the Stock Doctor program and may change at any time without notice.