Optimists Are Everywhere and Most Underperform – A Quick Look at the S&P500

gcopley
Print Friendly
Share on LinkedIn0Tweet about this on Twitter0Share on Facebook0

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

Graham Copley / Nick Lipinski

203.901.1629/203.989.0412

graham@/lipinski@sector-sovereign.com

February 1st, 2013

Optimists Are Everywhere and Most Underperform – A Quick Look at the S&P500

 

  • Based on the interest generated by our piece surrounding the performance of optimistic earnings guidance companies versus conservative ones within the Industrial sectors we have been asked whether this trend is seen more broadly across the S&P 500. There are some approximations necessary as we do not have the same degree of confidence in the data set that we have for Industrials and Basic Materials – but we get exactly the same results.
  • The analysis is further complicated by the Financials sector, as you would expect, given the near bankruptcies that we saw in 2008 and 2009, as well as the write downs and the Government intervention. Despite this however the trend is still seen within this sector.
  • The analysis does not work well in Energy, as the swings in commodity prices tend to overwhelm everything. For energy, the optimists spend a lot, but have good EPS growth: they underperform on return on capital.
  • Optimistic companies, defined as those who consistently overestimate annual earnings/growth, regardless of sector, show lower return on capital than their more conservative competitors. This leads to lower earnings and net income growth and lower shareholder returns.
  • Unlike Industrials and Basics, where we showed that the optimists did not necessarily outspend the more conservative companies, there are plenty of examples in other sectors where they do – most notably, Healthcare in R&D.

Exhibit 1

Source: Capital IQ and SSR Analysis

Note: in Exhibit 1 we show the unadjusted data. The EPS and net income data is highly influenced by the Financials sector and we adjust for that in the analysis that follows. Note that the return on capital bar is not as impacted – shows the “value” of a write down!

Overview

Following on from the piece we wrote in December about companies’ self awareness and the perils of being too optimistic, we extend the analysis to look at the S&P500. Again we assert that New Year estimates are more a function of company guidance than sell side acumen, as much because of the averaging process as because of risk aversion on the sell-side. We also assume that companies do not guide to earnings that they know they cannot meet and so we assume that consensus estimates reflect a conservative view of what companies think is likely. We take the view that any one year is subject to significant volatility (mostly outside any individual company’s control), but that a longer-term average should reflect the underlying view of trend earnings growth.

In our earlier work we showed that the Capital Goods sector is on average an under-estimator and that both Packaging and E&C are over-estimators. But we also showed that every sector has its optimists and its pessimists, sometimes in almost identical business and markets. We now show that this is true of the S&P 500 overall and most of its subgroups.

We have had to make some assumptions/adjustments to the analysis to get meaningful results and these are summarized as follows:

  1. We are only looking at the subset of the S&P 500 that has consistent earnings and estimate data from 2002 – this move cuts out about 80 companies. We then lose the five most extreme optimists and pessimists (conservative) from either end of the list – so we are looking at a pool of around 410 companies. In addition we should note that the S&P 500 constituents are those as of today.
  2. For financials we only show results for return on capital and shareholder return as all of the other metrics are too distorted by the financial crisis. In every case the optimist data set is very negative, which should not be surprising – the optimists took bigger risks and got into more trouble as a result. The profile for the S&P ex financials is shown in Exhibit 2
  3. In the Information Technology sector we start the EPS growth and net income growth analysis from 2004 as 2002 was a cyclical low for the group and the pessimist group had zero earnings in 2002.

Exhibit 2

Source: Capital IQ and SSR Analysis

In summary:

  • For the overall S&P 500, the optimist group has a 10 year average return on capital of 8.7%, while more conservative group has an average of 12.4%. Neither group has seen much growth in return on capital in the last 10 years, but both trends are incrementally positive.
  • Taking out Financials, the optimists have seen an average of 7.6% EPS growth from 2002 to 2012 while the pessimists have an average EPS growth of 13.3%.
  • The optimists have a total shareholder return that is roughly 50% of the pessimist group – ex Financials and it falls to 36% if we include Financials.
  • In short, the optimists underperform on every relevant metric we can think of.
  • The optimist group spends marginally less as a percentage of revenue on capital spending and quite a lot more on R&D – mostly this is a Healthcare effect.

This is a very important and very powerful conclusion as it suggest that aside from valuation, this may be an important factor to consider when taking a medium to long term buy and hold decision.

The charts below show the analysis for the S&P Sectors

Consumer Discretionary

Source: Capital IQ and SSR Analysis

Consumer Staples

Source: Capital IQ and SSR Analysis

Energy

Source: Capital IQ and SSR Analysis

Financials

Source: Capital IQ and SSR Analysis

Healthcare

Source: Capital IQ and SSR Analysis

Industrials

Source: Capital IQ and SSR Analysis

Information Technology

Source: Capital IQ and SSR Analysis

Materials

Source: Capital IQ and SSR Analysis

Utilities


Source: Capital IQ and SSR Analysis

©2013, SSR LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

Print Friendly