By Investment Master Class
“Estimates miss earnings, not vice versa” Market Veteran
An opportunity to purchase a quality business at an attractive prices often presents when a company misses a quarterly number and analysts downgrade their numbers to reflect the lower new estimate. This seems to have become more prevalent in recent times with investors and analysts having an increasing focus on short time periods, leading to an over-reaction in the share price. Fear, herding and other behavioural factors come into play. However, the key is to remain unemotional and analyse the situation in a calm and rational manner to form a view as to whether the earnings dip is simply a temporary blip in the business, or is symptomatic of issues that significantly impair the intrinsic value of the business.
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“I am particularly interested in buying companies when their long term prospects are intact but they are cheap because they face short term issues” Robert Vinali
"Companies that "miss" the analysts' consensus estimates can see their stock price decimated. Is the quarter-to-quarter earnings target really more important than a company's ability to increase shareholder value long term” Christopher Browne
Common causes of an earnings miss include a poor product mix, a lost contract, weather impacts, higher than expected costs, new management re-basing earnings, investment in the business or more aggressive pricing from a competitor.
It is important to remember, the intrinsic value of a company reflects the present value of the cash that can be taken out of the company over its lifetime. On this basis, one quarter, or even one years' earnings are unlikely to have a major impact on the long term value of the company.
“A couple of bad years of earnings shouldn’t determine the intrinsic value of those companies” Matthew McLennan
“The value of a business is determined by the present value of the cash it generates over its lifetime, not based on what next year’s earnings are going to be. While the first year’s cashflows in a discounted cash flow valuation carry the most weight in the calculation, years two through 20 and thereafter contribute many multiples of year one’s value in determining the present value” Bill Ackman
I am amazed at the number of analyst reports that focus on the upcoming earnings release as opposed to the longer term drivers of a business and its intrinsic value.
“Information with a long shelf life is far more valuable than advance knowledge of next quarter’s earnings. We seek insights consistent with our holding period” Marathon Asset Management
"Look beyond the next quarter and the next year and search, instead, for very long term trends" Ralph Wanger
When the analysts are talking about 'lower sales due to fewer days in a quarter', 'recent weather impacts' or 'poor share price momentum' it can be an opportunity for the long term investor to find mis-priced securities.
“It’s often a good sign when investors and analysts agree that ‘the stock is extremely cheap, but we shouldn’t buy it yet because there might be another bad quarter coming” Wally Weitz
Many of the Investment Masters spend their time thinking about the longer term business value. Remember a share is a part ownership of a business. Would a business owner sell a company on the basis of a poor quarter?
“In a time when financial television keeps score of quarterly “beats” (meaning a company beats estimates) we ignore financial models and are oblivious to consensus estimates. We don’t think quarterly “beats” are germane to intrinsic value. We prefer betting on company fundamentals, not investor psychology” Allan Mecham
Finding mis-priced securities due to short term issues is referred to as 'Time Arbitrage' and is one of the most profitable edges employed by the Investment Masters.
The next time a company you like, understand and think is high quality misses an earnings estimate, rather than run away it might be worth running towards it. The share prices of high quality companies will recover to reflect the longer term value residing in the company. It's just that the timing of any such recovery is unknowable.
Remember it's just an estimate. And estimates miss earnings - not vice versa.
“We think short-term earnings should be treated like appetizers at dinner: avoid overindulging or you’ll miss the main course.” Allan Mecham