It has been a busy reporting season both domestically and internationally. As usual, some great news, some good news and some you would rather not know about. For part 3 of our series on how our investment team assess real life investment situations, we explore why immediately after reporting season is the best time to buy shares with strong momentum.

The following information does not take into account your personal objectives, financial situation or needs. You should consider if the relevant investment is appropriate having regard to your own objectives, financial situation and needs. 

 

When we invest we look at valuation, bottom up fundamentals, growth prospects etc. All the things that are well covered by many industry participants. However, we also overlay momentum.

So what is momentum when it comes to investing in shares?

It is looking for factors in a share that show the company is running in the right direction. In many instances, immediately post reporting is the best time to judge these factors. There are a number of momentum factors but for now let’s focus on the main factor being earnings momentum.

Earnings momentum matters

The track record of a company’s historical earnings is important. However, the track record of a company’s future earnings estimate is even more important for determining share price returns. What do we mean by this?

As an example, let’s take a look at Facebook shares (note, for full disclosure AtlasTrend currently owns Facebook shares in one of its funds). The following chart shows the consensus earnings per share estimate for Facebook’s FY2016 earnings since 1 January 2015 which has increased substantially over the past 12 months. Why has this happened?

Either very high paid research analysts have been consistently underestimating Facebook’s earnings potential or Facebook’s management have been relatively conservative in its future earnings guidance. Both are great signs because it indicates a company that is able to consistently manage and beat earnings expectations. Since the sharemarket trades on expectations, that can only lead to one outcome, a higher share price.

We love an earnings estimate chart that looks like Facebook’s chart. We know from experience it usually means the company has the operational systems and people in place to keep delivering earnings upgrades. Once a company has this operational capability, it usually retains it for quite some time – success breeds success!

If you can buy shares with earnings estimate charts like this on a reasonable valuation then you should be onto a winner.

The reverse is equally (or perhaps even more) true. Once a company loses operational and earnings momentum over a period of time, it can be very hard to regain it. Usually it requires a wholesale change in management and strategies. See below Woolworths’ earnings estimate chart as a prime example.

With reporting season just finishing, most companies have provided some guidance as to future financial prospects. It is now the perfect time to look at any recently updated earnings momentum for your portfolio of shares.

We would suggest any shares with a string of earnings upgrades this reporting season and the last reporting season are well worth further investment consideration. If valuation (and other fundamentals) are right then it is likely the right time to buy before the next probable earnings upgrade arrives in the next 3 to 6 months.

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