Market sentiment has shifted through the course of the Q2 earnings releases with increased buying pressure from risk-on investors signalling the market could be about to turn. But not all stocks are benefiting to the same extent, which makes the quarterly updates an ideal way for shareholders to select the best way to buy the dip?
What Is An Earnings Estimate?
An earnings estimate is a projection made by industry analysts of what a firm's earnings per share (EPS) and total earnings might be. Top-rated analysts who work for investment banks, institutional investment funds or third-party research firms then see their views combined by agencies to give a consensus reading.
Coming up with an estimate of earnings can be a game of cat and mouse. Guidance is offered by the management of the firms about to release numbers in an effort to manage analyst expectations. The market doesn’t like surprises and as analysts don’t want to look too far off the mark, they’re keen to come in line. That can result in earnings estimates being downplayed, and on average more than 70% of firms ‘beat’ expectations. This makes those that do ‘flunk’ stand out to an even greater extent.
This quarter has produced a range of earnings misses, which will impact the returns of existing shareholders, but for those approaching the situation for the first time, Q2 misses can be a trading opportunity. It’s a question of whether the bad news is already priced in, and if this is a chance to buy shares in a firm that is about to turn a corner.
Q2 Earnings Season Misses – Snap
Growth stocks such as Snap Inc came into the 2022 Q2 earnings season on the back of a bad run for the tech sector as a whole. In the first six months of the year, the Nasdaq 100 index lost 29.79% of its value and Snap Inc stock was down an eye-watering 72%.
In May, the Snap management team took the decision to downgrade guidance on Q2 earnings, which had been offered just one month prior. At the time, Snap chiefs cited a macroeconomic environment that was deteriorating much faster than they had expected. The bad news for investors was that the subsequent 43% share plunge on 24th May was just the start of a stock-price horror story.
Misses on Top and Bottom Lines – Snap Inc Share Price Crashes
Snap stock crashed 25% in after-hours trading, after the firm released disappointing Q2 numbers on 21st July. The EPS figure was a loss of $0.02 compared to the $0.01 loss forecast by analysts according to Refinitiv. Total revenue of $1.11bn also disappointed with the already downgraded consensus estimate being $1.14bn, according to Refinitiv.
The bad news didn’t stop there. Investors were also unnerved by the firm’s unwillingness to offer guidance on how Q3 might pan out. The company’s statement stated that “forward-looking visibility remains incredibly challenging” (source: CNBC) and that sales growth in the early weeks of Q3 was “approximately flat” (source: CNBC) whereas analysts were expecting it to be up approximately 18%.
The decision by the firm to “substantially slow our rate of hiring, as well as the rate of operating expense growth” (source: CNBC) smacks of a firm heading in the wrong direction. At face value, this makes Snap Inc one of the Q2 misses to avoid.
Snap Inc- Daily Price Chart – 2022 – Earnings Miss on 21st July
Source: IG
From a technical analysis perspective, bottom-fishers can take some comfort from how the stock price has behaved as it approaches historical lows. The 2020 low of $7.89 per share hasn’t been breached, in fact, those brave enough to step in and buy Snap on 27th July, at $9.38 are already sitting on a 28.5% return.
The all-time-low of $4.85 posted in December 2018 can be expected to also offer support, but fans of the social media firm will have to approach the situation with caution.
Snap Inc- Daily Price Chart – 2019 – 2022 – Bottoming out?
Source: IG
Q2 Earnings Report Misses – Alphabet (Google)
Internet giant Alphabet, the parent company of Google, also posted a major Q2 earnings miss but proved how investor reaction to bad news can never be taken for granted. The firm missed on expected earnings and total revenue, but then in after-hours trading, saw its share price surge by 4%.
Alphabet earnings per share during Q2 came in at $1.21 compared to the Refinitiv estimate of $1.28 and total revenue of $66.69bn also missed the Refinitiv consensus estimate of $66.9bn.
It was also easy for investors to identify the business divisions which underperformed. YouTube advertising revenue was $7.34bn, which was lower than the $7.52bn expected. That slippage was put down to advertisers trimming their budgets and competition in the short-form video market from rival TikTok. Google Cloud revenue also struggled to make its mark – that area of Alphabet’s operations generated revenue of $6.28bn compared to Refinitiv’s prediction of $6.41bn.
A slide in revenue growth was also revealed. In the same quarter in 2021, Alphabet posted a 62% revenue surge on the back of a post-pandemic boom. The same quarter in 2022, by comparison, recorded miserly revenue growth of only 13%.
Alphabet Inc – Daily Price Chart – 2021 – 2022
Source: IG
That raises the question of how to justify Alphabet stock’s subsequent price increase. It could be partly down to a relief rally. The stock was already down by 23.7% on a year-to-date basis when the earnings were released on 26th July. Unlike Snap Inc, Alphabet has a broad range of income streams and that allows it to benefit from a variety of different customer bases. The Alphabet market capitalisation of $1.56tn is also far in excess of Snap’s $20bn and offers additional security to investors worried about which tech stock will come out of the current recession in best shape.
Another possible explanation for the Alphabet stock strength is the role that currency moves have played on the company’s earnings. The multinational is a global player that generates significant amounts of its revenue in non-US markets. That revenue is recorded in other currencies before being converted into US dollars on the company’s balance sheet.
Thanks to strength in the greenback, foreign income has effectively been devalued. That move has nothing to do with the firm’s business options and is potentially something that will become less of a factor, or reverse. If reports, which suggest US inflation could have already peaked, turn out to be accurate, then the US Fed can be expected to reduce interest rates before central banks of other major economies and that would trim the price rise in USD.
Q2 Earnings Report Misses – WarnerBros. Discovery
Whereas Alphabet’s earnings miss tied in with a surprise stock price bounce, the miss by media giant WarnerBros. Discovery (WBD) resulted in a textbook 10% price slide as investors bailed out of positions. The report released on 4th August was the first since the merger of WarnerMedia and Discovery and there was little time for the management to paper over the cracks exposed by that deal.
During Q2, WBD posted an EPS loss of $1.50 per share compared to the $0.01 expected loss by analysts polled by Refinitiv. The huge miss on that metric was matched by total revenue coming in at $9.83bn compared to analyst forecasts of $11.84bn.
WBD – Daily Price Chart – 2020 – 2022
Source: IG
WBD’s major earnings miss raises some interesting questions for potential investors. The report was delivered by new CEO David Zaslav who appears to be taking the approach of getting all the bad news out into the open whilst he can still attribute the responsibility for it to the previous management team.
Zaslav took on the top job in April and is promising to refocus the business and has targeted cost savings as his number one priority. For example, the DC film Batgirl was produced at a cost of $90bn and has been shelved without being released. Speculation is rife as to whether this is down to the quality of the film or accounting convenience, as recording it as a tax write-off removes significant debt and potential future liabilities from the WBD balance sheet.
The back-to-basics approach includes a move away from material produced solely for streaming services. Those films, according to Zaslav, have “no comparison to what happens when you launch a film in the motion picture, in the theatres” (source: CNBC).
This could be a classic case of a new boss using bad news to restructure a firm and take credit for the turnaround. With the firm now sporting an attractive P/E ratio of only 8.057, buying WBD stock now could represent a chance for long-term investors to buy an undervalued stock.
Statistics On Earnings Season Misses
One of the quirks of the earnings season is that the number of firms in the S&P 500 stock index, which beat EPS forecasts is on a five-year average above 75%. There are also interesting data points relating to the extent that firms beat or miss expectations. During Q1 of 2022, US companies reporting earnings and beating estimates did so on average by 4.9%, which is some way below the five-year average overshoot of 8.9%.
The influence that beats or misses have on stock prices can also be impacted by the nature of the existing shareholder base. Stocks such as Apple Inc are very popular with retail investors and passive fund managers. Those two groups own 41% and 20% of Apple stock, respectively. These buy-and-hold shareholders tend to be running long-term strategies and are therefore less likely to be influenced by one quarter of surprisingly good or bad earnings. This could partly explain why Alphabet (Google) share price rebounded on what, at face value, looked like bad news. Approximately 34% of Apple stock is owned by institutional investors and founders Larry Page and Sergey Brin between them own almost 6% of the company. They are unlikely to be shaken out of their positions by one round of bad news.
Active fund managers and speculative traders tend to focus on stocks that are at the more volatile end of the price-volatility spectrum. This group includes meme stocks and firms such as Snap, which did see its share price tank after its earnings announcement.
Historical data relating to share price moves of firms in the S&P 500 index shows that the stocks with the stickiest ownership tend to go up in value by only 0.5% when they beat earnings, whereas the average for the S&P index is 0.7%. The reaction is also muted when earnings miss, with the average price fall for sticky stocks being 1.4% but the average for the index as a whole being 2.3%.
Investors looking to buy stocks that can ride out earnings news, whether it is good or bad, might want to consider other names with high levels of passive and retail ownership. These include Johnson & Johnson (passive 24%, retail 30%), Amazon (passive 17%, retail 40%), Ford (passive 22%, retail 47%), and Exxon Mobil (passive 24%, retail 43%).
Final Thoughts
Earnings season misses can act as a catalyst for institutional investors to pull the trigger on trades they have been contemplating for some time. The additional information the reports give doesn’t necessarily have to be positive, just being able to take an up-to-date snapshot of the situation can be sufficient for big players to put their capital into play. Smaller retail investors who spot that strong buying support and trade with it, are putting themselves in line with the decision makers who ultimately drive stock prices.
Bad news in the form of an earnings miss can also result in short-term price weakness and offer more resilient investors an opportunity to get into positions at a lower level. This approach is best suited when firms such as WBD also have a plausible ‘turnaround’ story working in the background.
Whether you are an experienced investor or completely new to trading, earnings season is a time to spot new trends as they emerge. Trading with the trend is the secret to successful investing, but another is the need to use a trusted broker. The names on this shortlist of good brokers offer news, research, and analysis, to help you make the most of the opportunities earnings season offers.