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Dilantha De Silva
Dilantha De Silva
Articles (185)  | Author's Website |

Earnings Season Will Bring Good News for Investors

Increased volatility should be used as an opportunity to find mispriced bets

The fourth-quarter 2020 earnings season will officially start this coming Friday with a few major banks set to report. Citigroup Inc. (NYSE:C), JPMorgan Chase & Co. (NYSE:JPM), Wells Fargo & Co. (NYSE:WFC) and PNC Financial Services Group Inc. (NYSE:PNC) will all report earnings before the opening bell on Jan. 14, and the expectations have consistently gone up for the financial services industry as the U.S. economy gained steam in the second half of 2020. There are many promising signs, but investors need to remain cautious and be selective when shopping for bargains.

Revenue growth is finally set to turn positive

S&P 500 earnings and revenue growth plummeted to negative territory in the second quarter of 2020 as the coronavirus-induced recession took hold of the U.S. economy. Now, revenue growth is projected to be positive for the fourth quarter.

If this expectation materializes, the market will reward cyclical companies as earnings growth is expected to be stellar in 2021. The stock market is supposed to be forward-looking, and Wall Street analysts have consistently increased their expectations for 2021 along with the rollout of the vaccination program.

Even though overall revenue is expected to grow marginally on a year-over-year basis, there's nothing to suggest that investors should take the macroeconomic environment for granted. Chances are a select few companies will push the earnings bar higher, while the majority of them will report disappointing numbers. For this reason, carefully evaluating the prospects for business sectors and companies representing these sectors is critical to uncovering hidden gems this earnings season.

Analysts are turning bullish

When Wall Street analysts are forced to revise their earnings estimates upwards, that is always an early signal of positive momentum from a financial performance perspective. Many analysts and investors have been cautious about their projections for the better part of the past year, but earnings growth expectations for the fourth quarter have been revised upward multiple times over the last several months.

Source: Zacks

The U.S. economy has a long way to go to fully recover from the recession, but the analyst revisions to S&P 500 earnings is a clear indication that the economy is headed in the right direction.

Banks are in a tough spot, but there's a glimpse of hope for some names

There was nothing abnormal about the massive hit the financial services space took in 2020 considering the sensitivity of this industry to the overall health of the U.S. economy. For this same reason, it's easy to understand that recovery in business activities will lead to higher earnings for the banking sector. Net interest margins are still under pressure as a result of the decline in policy rates, which is one of the primary reasons for the disappointing performance of banking stocks in 2020. The macroeconomic situation, however, points to higher inflation in 2021, which would eventually lead to an increase in the federal funds rate. This is good news for banks, but investors need to carefully evaluate the prospects for the major banks before reaching an investment conclusion.

Even though major U.S. banks attract the interest of investors, it might be a good decision to look for banks that are undervalued relative to their earnings power, not just how big the bank actually is. Citigroup is usually a bank that is considered by investors as one of the least attractive players in the industry. However, the bank has not missed earnings expectations for the last five years, including earnings projections for 2020. The stock is still down more than 17% over the last 12 months and currently yields over 3%. Even though other banking stocks, such as JPMorgan Chase and Bank of America (BAC), have almost fully recovered from the March selloff, Citigroup has yet to show meaningful improvement. This presents a good opportunity for value investors as a recovery of the financial services sector in 2021 will inevitably lead to higher earnings for Citigroup, which is likely to translate into a higher stock price as well.

Even though the financial services sector is undervalued, it would make sense to allocate only a small portion of an investor's portfolio due to the significant uncertainties surrounding this space.

The construction sector is one to look out for

With mortgage rates at historic lows, the homebuilding sector is continuing to outperform the broad market. The construction sector, as a whole, has positive momentum going into 2021 as well. The stock prices of the major homebuilding companies, however, have increased sharply in the last 12 months. Therefore, it would be a good idea to focus on small yet profitable construction companies that are in good shape from a liquidity perspective. Green Brick Partners Inc. (NASDAQ:GRBK), which is the largest holding of David Einhorn (Trades, Portfolio), is attractively priced considering the stellar growth the company has experienced over the past couple of years. Even if interest rates increase toward the end of the year, the demand for new homes is likely to be elevated because of the low supply in the market. Investing in small companies such as Green Brick, however, carries significant risks. Therefore, the opportunities in the construction sector should be followed by growth-oriented investors.

One big tech name stands out from the rest

All the major tech companies have been at the center of the bull market that lasted for over a decade, so investors continue to believe in the ability of these giants to deliver the goods in the coming years as well. However, most of these companies, including the likes of Amazon.com Inc. (NASDAQ:AMZN), are currently trading at very high valuation multiples. The case with Facebook Inc. (NASDAQ:FB), however, is different.

The market value of social media companies declined sharply following the riots on Jan. 6, which pushed Facebook into undervalued territory once again. Facebook continues to be the leading player in the lucrative social media industry, and competitors are way behind the company from an active user perspective. In addition, both WhatsApp and Instagram are under-monetized at the moment. Once the threat of regulatory scrutiny subsides, Facebook will be well on its way to generating compounded annual revenue growth rates close to 30% over the next five years according to Wall Street analysts. For this reason, any weakness in Facebook's stock should be viewed as an opportunity to invest in a high-growth company at an attractive price.

Takeaway

The earnings season will kick off this Friday with major banks reporting fourth-quarter 2020 results. Share prices are likely to remain highly volatile in the next few weeks as investors get an idea of how companies have performed amid the challenges posed by the pandemic. Overall, earnings will be significantly better in 2020 in comparison to the previous year. For this reason, investors should ideally consider the expected volatility as an opportunity to identify lucrative investment opportunities that could lead to stellar returns in the coming years.

Disclosure: The author owns shares of Facebook and Green Brick Partners.

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About the author:

Dilantha De Silva
I am an investment professional with 5-years of experience in financial markets. I specialize in U.S. equities and incorporate a top-down approach to identify developing macro-level trends and the companies that would benefit from such trends. I am a strong believer that the best investment opportunities could be found in under-covered equities.

I currently work with leading financial publications including Refinitiv, Seeking Alpha, ValueWalk, GuruFocus, and TradeGrill to produce investment-related content.

I\\\'m a CFA level 3 candidate and an Associate Member of the Chartered Institute for Securities and Investment (CISI, UK). I am a registered candidate for the Chartered Wealth Manager program as well. During my free time, I enjoy reading.

Visit Dilantha De Silva's Website


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