Research Notes: Earnings Season So Far
A cautious Q2 is helping calm investors nerves.
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The bullish interpretation of second quarter earnings appears to be that, overall, results were “better than feared.” And it seems that interpretation is the one favored by the market at the moment:
The S&P 500 has gained 13% from an 18-month low reached in June. Earnings reports have clearly been a factor, both in terms of broader sentiment and in driving gains in some of the index’s leaders.
There are reasons for optimism, admittedly. Year-prior comparisons should get a bit easier in Q3 and beyond. On the whole, results don’t look terrible. With equities still down sharply from the highs — the S&P is off 14.5%, and the Russell 2000 23% — perhaps there really is a buying opportunity here.
In this space, we’ve been consistent in arguing otherwise. ROKU looks like a bear market rally — because it still looks like equity investors aren’t quite grasping the entire plot.
On Wednesday, I argued that Roku was a perfect example of this outlook. Investors still have not grasped the fact that equities in 2021 not only featured ridiculous valuations — at its peak, Roku traded at 27x eventual 2021 platform revenue, and had a market cap over $60 billion — but that those valuations sat atop unsustainable financial performance.
Meanwhile, Roku is now pointing to macro pressures in advertising demand driving year-over-year declines. But in Q2 2021, the company certainly wasn’t out there telling investors “we’re growing gangbusters because this is essentially the absolutely perfect environment for a streaming platform.” Just because 2022 is worse than 2021 on a relative basis doesn’t mean the current environment is bad on a relative basis.
It’s not just a revenue issue, but a margin one. Companies were able to take so much pricing, either directly or in Roku’s case somewhat indirectly (via strength in the ad scatter market). Put simply, investors looking for some kind of macro bottom need to first understand what an incredible macro top we just saw. From here, Roku’s results look far less like the result of a recession, and far more like the result of normalization.
Personally and professionally, we’ve been added to the long list of those burned by the “short TSLA” trade. Tesla stock has rallied (ugh) 32% since we recommended a short less than two months ago.
In that piece, we argued for a short thesis based not on some of the conspiracy theories (or, at least, conspiracy-adjacent theories) that bears have promulgated about the company and the stock. We don’t believe Tesla’s reported results are fraudulent. We don’t believe that Elon Musk is playing games with the stock.
But the last two months show why those theories can gain traction. Tesla’s Q2 results were…fine? There certainly appears little to assuage concerns about competition in China and elsewhere. There appears to be nothing that materially adds to the long-term uber-bull thesis that Tesla is “more than a car manufacturer”. Yet here we are, with a company that is just a car manufacturerseeing its valuation rise by nearly one-third in eight weeks. Here we are, with Tesla heading back toward a trillion-dollar market cap while economic and political uncertainty roils key growth markets.
It’s hard to blame a Musk-driven gamma squeeze for the gains, but given the list of choices we can understand why some investors reach for that type of explanation. Simply put, we don’t get it.
To be fair, some investors might well say the same thing about Amazon. A ~$1.4 trillion market cap is supported by first-half revenue growth of 7% and negative trailing twelve-month free cash flow. Q2 earnings didn’t look much better than those of Tesla, yet AMZN soared 10% after the report, adding a cool ~$120 billion in market cap in the process. (That’s an IBM (IBM) or an American Express (AXP) worth of value.)
But I argued this week that the stock still looks intriguing (though I personally have no position). The sum-of-the-parts case driven by Amazon Web Services, Prime subscription revenue, and advertising maybe doesn’t quite get to the “retail business for free!” case, but all three businesses are spectacular.
Largely unmentioned is a key question that I’m almost excited to see answered: how much money are these Big Tech companies
wasting “investing”? With layoffs across all of tech, we’ll get a bit of an answer going forward.
From here, it seems likely that Amazon is spending enough money on future-focused initiatives that it’s badly underearning here in the present. But, at least for now, it’s impossible to have a ton of certainty in that belief, or to assign a value near or above $2 trillion to Amazon stock based on educated (at best) guesses.
It really wasn’t that long ago that Microsoft was a dog. Here’s Microsoft’s adjusted earnings per share over a five-year period (fiscal years end June):
Fiscal 2012: $2.73
From the beginning of 2010 to the beginning of 2013, MSFT stock declined 12%. The NASDAQ 100 rallied 42%. Fundamentally and qualitatively, what IBM was in last few years of the 2010s Microsoft was in the first few years: a mature company being lapped by smaller, nimbler rivals and failing to drive any real growth at all.
Since the beginning of 2013 (the market began to position for the turnaround well ahead of time, interestingly enough), MSFT has gained 957%; including dividends, total return now clears 1,100%. Earnings have increased 230% over the past six years.
And yet, there’s an intriguing question: what did Microsoft really do differently? Obviously, the Azure cloud platform has been a big factor, but that wasn’t Microsoft’s idea: Amazon beat the company to the punch, and still maintains a healthy market share lead. More generally, the shift from on-premise to cloud has been a boon, particularly for Office 365, but that too wasn’t really Microsoft’s idea, but rather a broad trend across the software industry.
Microsoft hasn’t shot itself in the foot, certainly. There’s no deal as bad as the Nokia (NOK) smartphone acquisition (Microsoft paid $5.4 billion under former chief executive officer Steve Ballmer and sold the business for $350 million under current CEO Satya Nadella). But LinkedIn probably rates a ‘neutral’ (Microsoft paid just under 2x FY22 revenue, so it probably did OK ignoring the fact that it could have repurchased shares with that cash), and Microsoft likely missed out on potential deals (assuming it paid in cash, not in stock).
At the least, there isn’t some grand turnaround story to tell here. Nadella deserves some credit, and Microsoft clearly executes exceptionally well. But it is interesting how normal Microsoft’s growth appears, even in retrospect.
It’s difficult to take much of a lesson from that observation, whether in regards to Microsoft stock or investing more broadly. One lesson not to take is the “this turnaround could work — look at Microsoft!” card, a la “you have to buy the dip — AMZN went to $6 in 2001!”
Because what happened here to a large degree happened purely because Microsoft had such reach. Customers of dominant old-line manufacturers — Ford (F), General Electric (GE), Procter & Gamble (PG) — had customers use their products at least once almost every day. Microsoft customers use its products dozens of times almost every day. And so when the world changed in Microsoft’s favor, its earnings skyrocketed. Not many companies have that kind of reach.
It doesn’t seem like a coincidence that three of the companies that do have reach — Amazon, Microsoft and Apple — bucked the trend of cautious outlooks.
In essence, it’s starting to look like these names — yes, even Amazon — might be much more defensive than investors realized. The question is whether that’s necessarily a good thing at the moment.
After all, investors certainly seem to be pricing all three stocks as such. AAPL is now down just 9% from its highs, and using very basic technical analysis the stock seems headed to once again test resistance:
MSFT seems to have more room to run to the upside, but at 24x forward earnings (that’s FY24, by the way) is hardly inexpensive. As noted, AMZN is intriguing but it’s hardly a value play.
These are the leaders of this market — the stocks that investors appear to want to own. The problem is that in a bull market, these defensive names are usually the last ones to fall. See, for instance, Procter & Gamble (PG) in 2008-09:
I get the argument for owning these businesses long-term. History suggests, however, that a “flight to quality” despite valuation and macro concerns is usually the signal of a bear market rally rather than a bottom.
Stanley Black & Decker (SWK)
One of these companies is not like the others, admittedly. But I’m truly a bit stunned at how little attention has been paid to Q2 earnings from Stanley Black & Decker.
Revenue did increase 16% year-over-year. But per the 10-Q (p.44), organic growth was negative 8%. Volume fell 13%.
Adjusted EPS was $1.77 vs $2.81 the year before. Stanley Black & Decker slashed full-year guidance to $5.00-$6.00 from $9.50 to $10.50.
There are leverage and cost inflation factors at play, certainly. But this is one of the worst quarters you’ll ever see. And it seems like a screaming alarm for the home improvement industry. Each of Lowe’s (LOW) and Home Depot (HD) accounted for 15% of SBD revenue in 2021.
Here’s how the market has reacted:
Both home improvement giants have been sold off this year, admittedly, with HD down 26% year-to-date and LOW 24%. But both came into the year with almost absurd valuations: as we’ve noted before, HD traded at 26x 2021 EPS. Again, we see historically high multiples being applied to historically strong results — a hugely dangerous combination.
HD still trades at 18.6x this year’s consensus. It’s fair to ask why, exactly, investors are modeling in long-term growth from the current base, and why, exactly, those investors are treating HD as if it’s not a) cyclical and b) a retailer of goods.
From here, Stanley Black & Decker results seem like a canary in the coal mine. And no one is listening.
I’d be very cautious about owning either stock into Q2 earnings later this month. And I’d take a look at the options market. Straddle pricing for HD suggests a move from here through Aug. 19 (the Friday after earnings) of barely 5%. Modestly out-of-the-money puts look intriguing.
There’s absolutely a scenario where the story surrounding home improvement stocks changes dramatically two weeks from now. If that scenario plays out, the Stanley Black & Decker report won’t look like an outlier, but a harbinger.
As of this writing, Vince Martin is short Tesla, and not very happy about it.
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Musk and Donald Trump have been compared from time to time. One definite commonality is that some of their critics alternate wildly between accusing each of being too lazy, mercurial and/or ignorant to properly lead — and then accusing each of executing detailed, devilishly intricate, and/or long-range plans.
Yes, there are other businesses. Against a $925 billion market cap, they’re not moving the needle.