Four times a year, for just over a month, the Montaka research machine* is forced to find an extra gear above the intensity of the business-as-usual analysis that takes place at 45 Jones Street on a daily basis. These times come around a few weeks after the end of each calendar quarter as publicly listed US companies report financial results for the previous three months in what is known as Earnings Season.
By the end of this week the first, or March, quarter Earnings Season will be unofficially opened when the largest US banks (including Wells Fargo, a portfolio holding of Montaka) announce their results to the market. Over the next six weeks or so Earnings season will be in full swing. But what do we find out and what do we actually do during this period?
What do they give us?
Typically, each reporting company will release a slate of different materials to the market, available through news service providers or directly on the company’s website. The content often includes some or all of the following:
- Press release – a summary of the operating and financial results, usually accompanied by summary tables of financial results covering the earnings, financial position and cash flows of the business. Sometimes further detail is given by operating or geographical segment, and/or alternative earnings and economic measures by which to assess the company’s recent performance
- Presentation slides – a set of graphics and charts that support further understanding of the company’s results. These slides are typically referenced by management during scheduled conference calls to discuss the results with the financial and media community
- Financial statements – more comprehensive tables including profit and loss, balance sheets and cash flow statements. Like the summary tables given in the press release, these data sets may be accompanied by reconciliations of reported numbers to adjusted financial figures
What do they tell us?
Providing the requisite facts and figures is only half (arguably less than half) of the Earnings Season story. In addition to the published documents management teams participate in scheduled conference calls with financial analysts, typically from research houses like banks and brokers; the media; and interested investors. These calls are generally broken into two parts and last more than an hour in total:
- Prepared remarks. The company investor relations and senior management teams usually open the call with prepared remarks that will initially repeat a lot of the words and numbers presented in the press release. In addition, management begins to elaborate on the operating and financial conditions that drove the performance of the company during the quarter. The Chief Executive Officer (CEO) will talk about how the business operations performed against this. The Chief Financial Officer (CFO) will then take the call participants through a more detailed description of the financial results and expectations for future performance. Finally, the CEO usually reiterates the guiding strategy of the company
- Question and answer. The Q&A session follows the prepared remarks, and often lasts longer. In this section of the call sell-side research analysts have an opportunity to ask a couple questions each of the management team to dive deeper into the result. They will do this to improve their own understanding of the company and its ability to earn, as well as on behalf of clients that have outstanding questions and concerns
What do we do?
In simplest form our job through Earnings Season is to read the reports, comb through the numbers and listen to managements’ assessments of the numerous businesses they supervise, hoping to unearth insights that will help shape the Montaka portfolio.
We start by reading each of the filings and presentation materials for a company that has reported at the time they report (or the next morning if they happen to release results overnight). We understand what has happened to the business in the most recent reporting period and the financial results that have been achieved (or otherwise). We then take these numbers and make sure they are reflected in our historical financial model of the company we are reviewing.
Of course, we hand-enter every number into the model, ensuring we understand its significance and the true economics of the business. Moreover, this means we do not accept management’s adjusted financial figures at face value. Rather creating our own metrics by which to judge the business and tracking how they are progressing. We usually have plenty of queries off the back of this exercise.
To help us answer the why, what and how that arise from our first take of the result we tune into the management conference call. We listen to (or read that transcript of) management’s comments and responses to analyst questions in an attempt to add meat to the bones of the release.
Off the back of this process we will be in a position to summarise the insights gathered for the broader team and to update our view of the valuation goal posts for the company under review. Many times this process may not yield much change in our view of the business or its worth. But armed with new data points and perhaps a new and improved perception of the underlying business model, we may make significant changes to our valuations. This may lead to a new position entering the Montaka portfolio, or an existing position being scaled up, down or exited. In this way the Earnings Season process can have very meaningful implications.
How many do you do?
During Earnings Season we do not miss the opportunity to review each of the Montaka portfolio holdings, which typically amounts to a couple dozen companies on the long side and around three dozen on the short side.
In addition to the current holdings, we maintain a bench of prospective investment candidates that can total hundreds of companies. We like to read the releases and hear from management on as many of these as possible. It is commonplace for the us to review the earnings of even more companies that sit outside the portfolio, but may one day find their way into the fund.
Furthermore, we like to keep track of adjacent businesses to those that we hold or monitor as potential future investment holdings. These businesses include peers, competitors, suppliers and customers, as well as similar business models in different regions around the world. There’s potentially another few dozen here, which means that by the end of any Earnings Season the Montaka research machine* could have looked at the results of well north of a hundred different businesses around the world. This is one way that we connect dots and generate insights that we hope will lead to great investments that benefit our clients.
*Readers can expect that Andrew and myself roll up our sleeves on several dozen reports each Earnings Season to crank the machine as hard as possible. Fortunately for us, and Montaka investors, we also have George and Dan as colleagues and partners to supply a whole heap of horsepower each and every Earnings Season.