Chart of the Week: Largest share price falls during earnings
Opportunities arise when the market overreacts, and good quality companies are mispriced.
This week’s Chart of the Week comes from Morningstar’s market strategist Lochlan Halloway’s earnings analysis. The chart only assesses company results and ensuing market reactions up until the 21st of August.
Earnings season is always hotly anticipated. This half-yearly beauty contest provides long-term investors the opportunity to overreact to short-term results while traders try and profit from guessing the direction of this overreaction. At Morningstar, our analysts pay close attention to earnings, but the focus is on long-term results and valuations. A single earnings report usually doesn’t lead to a change in the long-term assumptions behind our assessment of a stock’s fair value, unless a company also comes out with new, material information that change our long-term assumptions. For example, new data on a drug that raises the probability of approval, or pricing gains in a key product line could affect an analyst’s long-run thinking.
The paradox of being an investor is that the only thing that matters is what a company achieves in the future. Yet all the information we have is historic. Many investors place an outsized importance on earnings season as it shows how companies, and their investments, performed. Although interesting, it defeats the purpose of investing, as we should not place emphasis on what happened in the past. Our focus should remain on the future. After all, we purchase shares not for their past performance or results, but for their future potential.
At Morningstar, we believe the real opportunities for investors occur when the short-term reaction to an earnings announcement is not in line with the long-term value of a company. Changes to our fair value estimates for a company can provide context to price movements.
Below, we can see the largest reactions to announcements by way of sell-offs.
Context is missing, however. It is important for investors to assess whether these sell-offs were justified by understanding the intrinsic value of the company. Morningstar analysts do this by assigning each company a Fair Value Estimate (FVE).
As a general trend, we see that most Fair Value Estimates remain unchanged or marginally changed most earnings seasons. There must be a material change in the outlook for the company to issue such an amendment.
Although not impossible, it is rare to see any sort of instance where a company’s intrinsic value depreciates by almost 30% (in the cash of James Hardie) after a routine earnings announcement.
You’re able to find previous editions of Chart of the Week here.
