You're listening to Strictly Business Podcast with Lindsay Williams.
With me is Samantha Hartard from Four Factor SA at 91 in Cape Town.
And we're going to talk about earnings revisions as a style of investing,
as a pillar of an investment philosophy at 91.
And Samantha, let's get back to basics first of all, if we can.
What is your approach to earnings revisions and why are they so important?
Why is that style so important to you?
Hi Lindsay, thank you.
So yes, you know, what is earnings revisions?
I think in short, we're looking to invest in companies receiving positive earnings
revisions that trade at a reasonable valuation.
You know, markets are forward-looking and today's share price is a reflection of the
market's expectations of that company's future and that includes earnings
expectations.
And we're looking to invest in companies where earnings have been underestimated
and they start getting revised higher.
and they traded a reasonable valuation.
We know that earnings are a key lead indicator to share price outperformance
over the medium term.
We're not looking for companies getting one-off benefit, you know, it can't be
things like such as a tax break or insurance claim that could come
through and flatter earnings over one year.
We're looking for companies that are going to get multi-year positive earnings
revisions,
either from an operating environment that is suited to them, operating efficiencies
that management teams could be putting in place,
management taking decisions that could create competitive advantages,
strategic advantages that will see these companies continue to receive positive
revisions of the medium term.
Okay, so let me put this into layman's terms now.
I love examples.
Let's say that Hartard Industries put out a voluntary trading update on the Stock
Exchange and
YouService to say It's with reasonable confidence that we expect our earnings per
share and headline
earnings per share to be between 10 and 12 percent higher over the period under
review.
And you look at it and you say, OK, that's fine.
That's what we expected.
Then two months later, Hartard Industries comes out with it is with reasonable the
same stock exchange
new service voluntary update.
It's with reasonable confidence that we expect.
The company's headline earnings per share and earnings per share to be between 17
and 20% higher.
That immediately alerts you.
Is that correct?
Yes and no.
So, you know, when a company releases a trading update or their financial results,
that news is then, you know,
captured into the share prices.
So a company comes out and guides, as you said, 5 to 10%, some with points of 7.5%
up.
The market already knows that.
And what we're looking to do and our analyst team is looking to do, see what
the market is missing.
So that obviously involves a lot of fundamental bottom-up research by our
analyst team,
seeing what the outlook is for the companies, their operating environments,
what the management teams are doing.
And we measure where our analysts'expectations are relative to
consensus expectations.
And that is such a key, pretty much the starting point, the key focus of where we
go as a team.
And if we see that our analysts are...
comfortably ahead of market expectations let's say 10 12 above um where consensus
is that's a really strong steer
for us that this is a great idea let's have a look at what the valuation
multiples are trading at the moment for this company um and that would be
our bread and butter you know we'd say our you know earnings 101 earnings revisions
101 um so trading up
there comes through at seven and a half percent let's say the market was expecting
that stock to to you know be growing at about 15 percent i
mean And of course, that would be taken very negatively.
You'd see probably earnings expectations getting revised lower, the stock derating.
But that also presents an opportunity.
Has the market overreacted?
What does our analyst see?
Could this be the bottom of a negative earnings revision cycle and the start of a
positive trajectory to come?
And that's where the debate takes place with our team.
Relative to consensus expectations is a very key phrase.
And I've been talking about the revision style of investing with you and your
colleagues over the years.
Thank you.
That's the first time it's really sunk in with me, but also the market reaction as
well.
I mean, if the market reacts before you can react, then, of course, the moment is
lost.
When does it and when doesn't it work?
Are there economic cycles where this sort of thing doesn't work?
Tell me failures and successes or other examples of.
Yeah, look, you know, no investment style works all the time.
You know, we wish they would and earnings revisions included.
And for us,
it is at inflection points in the economic cycle or market conditions that don't suit
our investment
philosophy.
When share prices start to decouple or become uncorrelated to what the earnings
revisions
profiles have done with companies.
Market conditions that most suit us are upwardly trending markets where you can
see clear movements in earnings
expectations, how they are changing.
and therefore share prices being able to react and start to price in those changing
or evolving earnings
expectations over the medium term.
The investment opportunities in this style obviously go through phases, Samantha.
I mean, there'll be times when there are revisions, downgrades, and that comes to
my next question, which is.
If you're already holding an asset, a security, and suddenly there are revisions
to the downside,
and it may not be just for one quarter or one half year, but for a full year, do you
say to yourself, okay, I'm going to get out of this company.
It doesn't just work on the upside where you want to get into the company or
increase your holding.
It can also mean disinvesting.
Yes.
So, you know, there are two elements to the investment philosophy.
Our bread and butter is when a company is trading at a really reasonable valuation,
or in fact, cheap.
in our minds and is getting positive earnings revisions, that's exactly where
we want to be placed.
And companies that are trading at very high valuation multiples get negative
earnings revisions.
That's exactly where we want to avoid.
The two areas where there are most debates in the companies or on the team is where
you're talking to.
So we've gone through a period where we've invested in a stock, it's getting strong
positive earnings revisions,
it was trading at a reasonable valuation at the time that we entered into it.
And what inevitably happens is that the market starts to...
to price in this positive outlook,
starts to price in this growth that the market had previously underestimated.
And it's at that point, let's say, you know, after a 12-month or
24-month horizon where the market's caught up to our analysts that we then debate
with ourselves, okay,
have market expectations now caught up to where our analyst is trading at the
moment?
And therefore, should we start looking to take profits in that name?
It is at those points in the cycle that we become most sensitive.
And typically, yes, that's where we would start to reduce exposure and take profits
on those names
after a very strong re-rating.
And we think that the momentum in the positive earnings trajectory is about to
slow or stop.
But remember, the flip side of that is also really powerful.
If there's a stock that has been expensive, it's been going through a
period of negative earnings revisions.
But analysts turn to us and say, actually, we think this is the end of the negative
revision cycle.
That can also be an equally strong steer for us to say, this is a great opportunity
to review and perhaps take exposure.
Final question.
Actually, it's not the final question.
I've got two.
But the first of the final two is, you know, I spoke to one of your colleagues,
I think it was Hannes van den Berghe a few months ago, and we spoke about earnings
revisions.
And the podcast was crackling with optimism from his point of view.
He said, we are seeing so many opportunities.
Is that what you found recently?
Absolutely.
And in fact, it continues.
So I think you may have spoken to him in the second quarter of this year, pre the
election.
And what we saw post the election and the formation of, you know, the government of
national unity, the GNU,
as we call it internally, is that a lot of the South African ink names actually
rallied quite strongly.
So you've seen the banks up.
You know, 30% the retailers, up 30% insurance,
insurers up 30% since that year new announcement.
In our minds, that was really the market just re-rating so many of our sectors back
to their
long-term average PE multiples.
The next leg of the cycle and why we're still excited is that we think that the
positive earnings revisions trajectory still needs to come through and it is
being underestimated by the market.
You know, the work that our retail analysts, insurance banks analysts have
been doing are showing far greater upside to where
earnings expectations are today.
And so we think that this market in SA still has legs to go,
despite the strong start that you've had over the last four months.
You've answered the second part of my final question, Samantha.
Thank you very much for your analysis.
And again, the optimism comes through chatting to you today.
Samantha Hartod is from Four Factor SA at 91 in Cape Town.
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