Thu, 17 Jan 2013
Unless a company reports quarterly results that stray wildly from expectations, it's best to keep a long-term view on a stock, according to Morningstar's Heather Brilliant.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here with Heather Brilliant. She is our global director of equity research. As we start of fourth-quarter earnings season, we'll look at what investors should keep on their radar screens and what it could mean for their portfolios.
Heather, thanks for talking with me.
Heather Brilliant: Thanks for having me, Jeremy.
Glaser: So, a lot of us are long-term investors. Should we be even focused on short-term earnings--one quarter here, one quarter there? Is it something that's even worth watching?
Brilliant: Well, yes and no. On the one side, there can be I think way too much attention paid to quarterly earnings and people get very excited about and very disappointed at whatever a company reports for the quarter. But at the end of the day, what we're really looking for is what kind of signals there are for the long term within that quarterly earnings report.
So, within a given quarter, you can find some incremental information on occasion that can lead you to feel more confident in your thesis on a stock, or it can lead you to realize perhaps it's time to question the thesis. But other than that, we really try to stay away from the noise of quarterly earnings and focus on the long-term fundamentals of the businesses.
Glaser: So, what are some cases when analysts would change their fair value estimates due to quarterly earnings?
Brilliant: Well, one example is Aeropostale actually where the company reported very poor same-store sales growth to the tune of 8%-9% down, and we were expecting about a 1% decline. Well, there are two problems with that. First is that's quite a lot less cash generated than we expected in the quarter. And the second is that it really calls into question what the long-term strategy is. When you think a company is just going to be mildly negative when it comes to something like revenue growth and it ends up being extremely negative, you have to really take a second look and see whether your assumptions for the long term make sense.
Glaser: If the fair value estimate says the same, is that saying that [the company's performance is] absolutely in line [with expectations], that there is nothing wrong, or is there something else going on there?
Brilliant: No, not necessarily. In a lot of cases, we'll see situations where the [quarterly results] may have been slightly above or below what we're expecting, but it doesn't necessarily change our long-term view. And at Morningstar, since we take a long view we're really looking at the cash flows the business can generate over the next five, 10, or 20 years. And what that means is that, when you boil that down to incorporating a single quarter, it has to be a pretty meaningful difference from our assumptions to cause us to change our fair value estimate.
Glaser: What are some of the expectations for this earnings season?
Brilliant: Generally speaking, I think we have some pretty straightforward and, I would say, even relatively conservative expectations for the companies that we cover. And what that means is that, if the U.S. economy and the global economy kind of come in, in line with what's generally being forecast, somewhere in the neighborhood of 2% growth for the U.S., much less for Europe, we'll probably see our fair value estimates stay relatively the same. But if we do see some companies really start to surprise on the upside and report much stronger-than-GDP revenue growth, I think we'll really have the opportunity to see some fair value estimates increase.
Glaser: Moving into earnings season, is there anything that looks attractively valued right now or things that maybe people should have on their radar?
Brilliant: Well, generally speaking, it looks like the market is pretty fairly valued. In fact, it's trading at exactly 1 times our fair value estimate, which is relatively unusual. If you look over time, it's been wildly overvalued, wildly undervalued, even just in the last 10 years. But right now we're pretty much sitting smack dab at fair value. We do think the energy sector still looks undervalued, and it's pretty much the only sector where we would see any meaningful difference from fair value in the aggregate. It's trading at about 0.92 times fair value.
We also see some opportunity in some individual companies. Wide-moat companies, generally speaking, are trading pretty close to fair value, as well. But there are a few companies that we would [suggest to] keep on your radar in case the market starts to decide to make them even cheaper, and National Oilwell Varco and Express Scripts would definitely top our list in that regard.
Glaser: Heather, thanks for your thoughts today.
Brilliant: Thanks for having me.
Glaser: For Morningstar, I am Jeremy Glaser.