Reporting Season: What to Look For
George Clapham, Arnhem Managing Partner.
I have experienced many reporting periods over the past 32 years as an analyst and portfolio manager, but one always needs to know what to look for and what matters most when a company delivers its report card. Of course, the first thing analysts typically look at, is whether the company’s earnings meet expectations. Although this is obviously essential, we see more and more companies pre-reporting nowadays, given the requirement to keep the market fully informed. What matters to me the most is not necessarily the company hitting or missing expectations, but the factors that will determine future growth and shareholder value creation over the next few years and beyond. Here are the seven things I consider important when reviewing a result.
1. EPS growth.
The growth rate of earnings per share is clearly a long term driver of value. Surprisingly, this number can be hard to find in both company releases and broker reports. Nevertheless, it is an essential metric and speaks volumes about the company’s future prospects.
2. Organic revenue growth.
That is growth in the revenues excluding acquisitions, divestments and currency movements. This gives you a picture of the true earnings of a company’s business endeavours, without the distraction of other external factors which effect revenue.
3. Trends in key value drivers.
The main ones I look at are ROFE or return on funds (or capital) employed and operating profit margins. If both are expanding then the company’s growth prospects are looking good.
4. Cash conversion.
This is an earnings quality measure. Typically we use ratios to compare reported profits with cash profits. For example, we look at gross operating cash flow (in the cash flow statement) as a percentage of earnings before interest, tax and depreciation.
5. Balance sheet changes.
For example, an increase or decrease in net indebtedness or provisions.
6. Capital management.
Dividend growth and capital returns are an important component of total shareholder returns and account for about half of total returns to equity holders over the long term. A sensible capital management policy is therefore critically important. I prefer companies that maintain a sensible payout ratio, typically below 70%.
7. The growth outlook.
I always look at management’s outlook statement for the next year and beyond and consider if the industry dynamics are supportive of their expectations. Then, I will look at what other analysts have factored in for growth in the following one to two years after the reported result, knowing full well that these estimates are typically optimistic. Interestingly, most companies provide guidance nowadays but many do not present the assumptions that form their expectations.
With reporting season upon us, myself and the Arnhem team will be paying close attention to the above factors. There are always pleasant surprises and unexpected disappointments, but throughout the reporting period, we always keep in mind one thing: How these results point to delivering sustainable earnings growth and value creation in the future.
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