Assessing Quarterly Results

Under Armour (UA)(UAA) reported results for the first quarter of 2018 at the beginning of May. I won’t bury the lede: I thought it was pretty uneventful. From my perspective, the story is unchanged. Of course, we’re talking about three months of business results. The fact that little has changed in the past 90 days shouldn’t be too surprising. But I might have come to a much different conclusion if I solely relied on others to tell me about the company. Here’s a short list of some Under Armour articles that were published on the day of the earnings release:

“Under Armour Sows Doubt”

“This Is the Shoe Under Armour Is Banking On to Save Its Business”

“Under Armour Is Threatened By This ‘Ticking Time Bomb’”

“Under Armour Still Under Siege in the U.S.”

It’s hard to be a long-term investor when you’re looking at these kind of headlines. There’s a lot of noise, especially around quarterly earnings. If you don’t have conviction in your thesis, that endless chatter will lead you to the conclusion that you’ve got to do something. This problem is exacerbated by an environment where some media outlets rely on hyperbolic headlines to grab the attention of potential readers. If your objective is to stay levelheaded and focused on the long term, these kind of headlines won’t help.

The same idea applies to watching short-term stock price movements. Consider the volatility in Under Armour shares following the quarterly results: It was up premarket (probably because the company “beat” analyst expectations), then down about 5% by noon, and finally up about 5% at the close (the plausible explanation for the negative headlines is shares were lower in the morning when those articles were written). You can see from this example that relying on moves in the stock to determine if it was a good or bad quarter is not a smart idea. That’s just as accurate if you expand your time horizon to weeks or months (take a look at the swings in UA’s stock just since the start of 2018). If you take your cues from Mr. Market, you’ll end up chasing your tail.

If you’re trying to be a long-term investor, none of this helps you towards that goal. On the contrary, it probably makes your life more difficult. Here’s a potential fix: when a company reports earnings, stay away from the headlines and the stock price. Read the press release and the transcript and come to your own conclusions. I realize that’s difficult to do in a world where we’re constantly connected to phones and computers. We seem to have an insatiable thirst for seeing what others think, even when there's reason to believe they are not particularly informed on the topic they’re discussing.

If staying away from headlines and pundits is too extreme, I think there’s a workaround. We need to approach articles, blog posts and analyst reports with a constant focus on the long term.

A good place to start would be to disregard analyst recommendations and price targets. For what it’s worth, I think most analysts produce quality work. They have a good understanding of the companies and industries they follow. The problem is that analysts set their price targets based on where they expect the stock to be in 6 - 12 months. As a result, they're drawn to companies they expect to beat next quarter’s consensus estimates and raise guidance. They are less interested in high-quality businesses that face short-term issues or lack a “catalyst.” When it’s unclear if current issues will last six months or six quarters (which is usually the case), most analysts head for the sidelines. That’s an opportunity for investors with the patience to wait for these issues to shake out (obviously you must be correct that these problems really are temporary). I think that’s a good place to fish.

Conclusion

I think you should approach articles, blog posts and analyst reports with a clear focus on answering two questions:

• How does this impact the competitive position of the business?
• What does that mean for the intrinsic value of the business?

Consider what Paul Black, co-CEO and portfolio manager at WCM Investment Management, said during a recent appearance on the Capital Allocators podcast (with light edits):

“We’ve made the mistake in the past of buying high-quality, wide moat businesses cheaply. What we learned because of our mistake, from significantly underperforming the market, is you’ve got to stay focused on the direction of the competitive advantage. Every organization is either getting stronger versus its competitors or its getting weaker. You want to be able to make the case through pattern recognition and other tools that the company that you’re looking to invest in has a strong likelihood of growing its competitive advantage over the next 5, 10, and 15 years. And if you get that right, any valuation work you do is going to look ludicrously cheap 5 and 10 years out.”

There’s one other action I recommend: reading the 10-Q. Consider, for example, the agreement to sell some account receivables that Under Armour entered into during the first quarter. What's the rationale for this business decision? And why wasn’t this mentioned in the press release or on the conference call? These are the kind of questions I find most revealing.

Whether a company beats or misses consensus estimates by a penny is irrelevant for the long-term investor. As I noted earlier, what happens in any three-month window will be difficult to separate from noise (and can be easily manipulated within the rules of GAAP accounting).

If you can stay focused on the long-term competitive position of the business and take the quarterly swings with equanimity, I think you will do well in the long run.

Disclosure: Long UA.