During the period when companies are reporting their quarterly results, there are large moves in share prices. How should investors look at these movements? I came across an article on masterinvest.com that should help us.
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 analyze 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. 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. An amazing number of analyst reports focus on the upcoming earnings release as opposed to the longer term drivers of a business and its intrinsic value. 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.
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? 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.
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