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Earnings Season Survival Guide

Earnings Season Survival Guide

Earnings season was usually a feel-good time of the year … that was in the “Before Coronavirus Era.”

It’s only been a month or so, but it feels like those times are ancient history.

In a typical quarter, the vast majority of companies beat the average analyst forecast. For example, nearly 70% of S&P 500 Index companies topped estimates last quarter. Then corporate management hopped on a conference call and talked up financial milestones or new products.

This time will be very different.

First-quarter earnings will take an historic hit from the coronavirus lockdown. That’s a given. Just think about how many public companies have completely halted most of their business activity, such as Royal Caribbean Cruises Ltd. (NYSE: RCL), Delta Air Lines Inc. (NYSE: DAL) and AMC Entertainment Holdings Inc. (NYSE: AMC). Not to even mention the companies that have had to substantially reduce activity.

Analysts have been slashing their earnings per share estimates for all quarters this year. Just take a look at this chart:

change in S&P500 earnings since dec 2019

First-quarter earnings estimates for the S&P 500 have been cut 14% since the year started … and second-quarter estimates are down nearly 25%!

Here’s How to Sift Through the Bad News

This time around, you’re not going to hear about growth opportunities or acquisitions. Expect language that would send investors fleeing for the hills in normal times … falling revenue, shortages of critical components, suspended dividends, you name it.

This is going to be true across the board. So try not to panic or get caught up in that kind of bad news. Instead, you should focus on liquidity and plans to weather the storm.

Here’s what to look for:

  • Cash is king: Understand all cash avenues available to a company. This includes current cash on the balance sheet or cash available through lending facilities with banks. Companies can also preserve cash by suspending share buybacks and dividends.
  • Debt: This is especially pressing if a company has an upcoming debt maturity. Will they retire the debt and face a large cash outflow, or refinance at a potentially much higher interest rate?
  • Restructuring: This is corporate speak for cutting costs. Look at how companies are creating more flexibility in their cost structure. The more variable costs, the better.
  • Compensation: Check if management teams are cutting their own pay, especially if the firm was forced to lay off workers or needs to tap bailout funds. Firms will have to win back the same employees they’re laying off and avoid political crosshairs.

And there’s something else to watch for: Companies that are most blunt and transparent about their  bad news could be rewarded with higher stock prices.

That’s because investors will take comfort in knowing the full extent of the impact from a shutdown economy … instead of guessing how bad conditions really are.

So this quarter will be ugly, but this round of earnings reports will at least provide a real-time glimpse into the severity of the downturn and give us an idea about this earning season.

It will also give you the chance to check in on bargain buying opportunities, including U.S. Bancorp (NYSE: USB) and  Dell Technologies Inc. (NYSE: DELL), which are up 16% and 12% since my recommendation.

Best regards,

Clint Lee

Clint Lee

Research Analyst, The Bauman Letter

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