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Reporting season is almost on us: here's why you need to pay attention

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The Australian corporate reporting season in August provides valuable information for individual and institutional investors.

Whether investing the first $1000 earned from an Instagram account, steering a self-managed super fund (SMSF) or navigating the markets for a multi-billion dollar hedge fund, the insights from company management teams can help investors set their sails for the half year to come and beyond.

The sales, revenue and profit information revealed in each company report provides an important health check, and in some cases a reality check. Did the online retailer really see a surge in sales during the lockdown? Is that travel company on the verge of insolvency, or did the government's support package make the difference? Those are the sort of questions that company reports could answer in this most unusual reporting season.

reporting season why you need to pay attention

Those who follow the share market know that investors here and around the globe are looking through the damage to company bottom lines caused by the virus containment measures. The share market rallied hard from the March low in anticipation of a quick economic recovery. While the financial results for the first half of 2020 will likely drive the headlines, it may be management outlook statements that will spur the most significant moves in share prices.

In more conventional times there are two important factors that determine whether a share price will rise or fall after the company reports. The first is the trend in sales, revenue, profit and other important metrics.

The most important metrics depend on the industry and the company itself. For a resource company, this could be production and the price achieved for their output. Shareholders in a mature company may look at trends in profits. In banks, net interest margins and bad and doubtful debts may be most important, while for a growing biotech or online software provider, sales may be the most significant consideration.

Investors should know the most influential factors for the stocks they hold and any stocks they are considering buying.

The second factor that drives share price reactions is any earnings surprise in a company report. It's not the earnings themselves that drive share price reaction to a company report, but how the actual earnings compare to consensus expectations.

The US company reporting season in July illustrated this dynamic. JP Morgan reported earnings per share of $1.38, well below the previous corresponding quarter's $2.59. However the average estimate of earnings for the second quarter of 2020 was $1.01. Over the next two trading days, JP Morgan shares rose by more than 3%.

Many studies show that the most reliable predictor of share price moves is earnings revision. When earnings surprise, either positively or negatively, it may prompt analysts to change their forecasts for the future. Although in the short term other factors such as "buying the rumour, selling the fact" are in play, over the medium term the revision of earnings is a top indicator of share price direction.

These are the drivers of share prices derived from long experience. The challenge for this company reporting season is that the market environment is close to unique. In the first half of 2020, the Australian share market hit its all-time high, and a seven-year low, as the global economy was hit by a once in a century pandemic.

Additionally, the future is more than usually opaque. How severely will secondary and possibly tertiary outbreaks affect the economy and the market? What capacity do governments and central banks have to respond, given their already historic levels of support? No-one can give definite answers to these questions.

These extraordinary conditions may hold the clue to what will separate winning and losing stocks over the reporting season. As investors, and as human beings, we crave certainty. Management teams refusing to give forward guidance to shareholders would be perfectly understandable. However, companies who are prepared to describe in detail how they see the future could receive the highest levels of investor support and better share market performance into 2021.

The information presented in this article is general in nature and should not be considered personal or financial advice. Seek independent advice and consider the relevant Terms and Conditions at cmcmarkets.com.au when deciding whether to invest in CMC Markets products. CMC Markets Asia Pacific Pty Ltd (ABN 11 100058 213 AFSL No. 238054)

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With more than 30 years' experience in the financial markets, Michael McCarthy is the chief market strategist for CMC Markets for Asia-Pacific. He provides local and global market analysis for the Asia-Pacific region, formulates trading strategies and plays a key role in educating clients. Michael has a Masters of Applied Finance from Macquarie University and specialises in derivative trading.
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