The results are in for the first quarter earnings season in the US and do not make for pretty reading. For the sixth consecutive season, operating earnings of the largest companies have declined. A little over one fifth of companies issued earnings guidance and, of those, 71% advised analysts to lower their expectations. The gradual erosion of the earnings base of the country’s largest companies has taken its toll on the valuation of the stock market.
The valuation of the market peaked in May 2015, just over a year ago. There was a first quarter rally on the back of more monetary easing in Europe, but the impact on US companies is likely to be short lived. When the ECB announced that it would be buying European corporate debt, this boosted the value of debt and pushed down the yield that borrowers have to pay. Large US companies can take advantage of this to raise debt in Europe and use the proceeds to buy back shares to temporarily support stock prices.
The decline in earnings also has a short term impact on valuation, by raising the market multiple, but as the chart shows, the more powerful force is the growing momentum out of US equities in response to declining profitability.
There is some good news, however. OTAS makes it easy to filter a market or portfolio of stocks to find those where the trend in earnings is bucking the general malaise. There are 33 companies with falling share prices and rising EPS estimates, where this contrast is sufficiently significant to stand out from the rest of the market. Ten of these shares are in the energy and materials sectors, which are whipsawed by the anticipated moves in currency and commodity markets, but the remaining 23 shares are trading at a 22% discount to the average valuation of the broader market.
By applying one filter for stocks with significant divergence between falling price and rising EPS estimates, and a second excluding energy and materials shares, in just a handful of clicks we are left with a chart showing only the outliers across the whole market. Hovering over each yellow disc reveals the name and recent performance of the company. Frontier Communications is highlighted below.
Double clicking the name takes you to the EPS Momentum page for Frontier Communications and to a chart that shows the relationship between the share price and estimates of upcoming earnings. In the case of Frontier, investors were faster than analysts to realise the downgrades that plagued the last nine months of 2015, but both analysts and investors have been in step since the beginning of this year. Then the share price weakness over the past month contrasts sharply with the average 8% upgrade to forward earnings posted by the analyst community.
Obviously it is up to investors to decide whether the recent share price weakness heralds another false dawn for the company, but OTAS provides layers of analysis to help make this judgement. For example, Frontier’s estimates have risen for the years to December 2016 and 2018, but fallen for 2017, so it may be that investors are most focused on next year. Frontier’s borrowing costs over seven times that of its industry peers and the shares may thus have reacted to the renewed prospects for a summer rate hike. Frontier will also pay a dividend in 20 days times and has a forward yield of 8.6%, but while free cash flow covers the pay-out, earnings do not.
All of these factors influence the decision to buy or sell Frontier, or indeed any stock. OTAS provides a one-stop shop for all the market intelligence that you need to make sure that you are as fully informed in your trading or investment decision as you can be. OTAS also draws out the priority issues that are impacting share prices, to help fundamental investors frame the most pertinent and timely questions when they interrogate a company’s performance, its financials and its management.