Earnings have always been about managing expectations and the most recent period has been no different. After drastically reducing and, in many instances, suspending guidance due to the uncertainty and the onset of the COVID-19 pandemic in the early part of the year, the read from most companies is that things are recovering. 2020 is being looked at as a throw away year and 2021 for most sectors and industries appears on track to resume sales and earnings growth progression especially versus the more normal 2019. It seems that consensus estimates for the second quarter were far too pessimistic. Companies beat, often very strongly in the case of those that we view as being of high quality and low leverage, and price performance didn’t align with what those beats would have earned them in the past. Sentiment towards the current earnings period by investors and analysts has been muted and somewhat skeptical regarding the sustainability of progress for most, with the exception of a select group of cohorts that appear to be benefiting from the stay-at-home economy for whom markets are discounting very optimistic assumptions and are attracting rich multiples.
There is reason, however, to be skeptical of overly lofty valuations at this point. There has been much stimulus offered to companies recently with the intention of seeing them through rough times, but it as yet remains unclear how long this protracted period of stress will continue and if stimulus measures wane at a point many of the lower quality, higher valuation businesses may see significant drawdowns. The most forward-looking management teams we have spoken with are using their time during the downturn to strengthen their businesses, either by increasing the efficiency of their operations or by taking market share from lower quality, less insulated competitors – oftentimes both.
If you’d like to continue the discussion, please don’t hesitate to reach out to us.