The financial year 2017 reporting season is now underway and according to the latest IBES consensus earnings estimates, earnings per share growth for the ASX 200 index is forecast at 13 per cent in financial year 2017, slightly down from 13.6pc at the end of the first half of 2017.
This would still mark the end of the earnings recession after two straight years of contraction. We are confident that the improvement in the economic outlook will translate to earnings over the next 12-18 months so long as the positive conditions are reflected elsewhere, outside of Resources. We think outlook commentary and how management chooses to deploy capital may be as important as reported numbers.
The top 200 industrial companies are expected to grow profits by 8pc in financial year 2017 despite some negative earnings momentum heading into reporting season. The scarcity of growth outside of Resources pushing valuation ever higher in stocks that enjoy strong and dependable growth in earnings.
We caution however that the divergence between the most expensive (high price earnings) and the cheapest (low price earnings) stocks remains extended and that the market’s recent treatment of disappointment from high price earnings stocks has been brutal.
This divergence presents opportunities in overlooked areas among select industrials where earnings momentum is recovering and where there is more valuation downside protection if the earnings recovery proves premature.
Investors need to handle high growth stocks with increasing care. Regardless of company fundamentals, we also caution that the high price earnings/growth segment is vulnerable to blanket selling in volatile markets (i.e. a price earnings de-rating) simply by virtue of how strongly it has held up against some recent market weakness as investors have bought these companies for dependable and growing earnings.
High valuations make for high expectations. Companies that have missed expectations continue to underperform. While the average consensus downgrade of companies that have updated market is approximately 10 per cent the share price reaction since the downgrade has been far more severe at approximately 16pc.
Stocks with high valuations with some earnings risk we see as the most vulnerable include Domino’s Pizza and CSL. Again see our reporting season preview for more detail. Morgans preferred growth stocks focus on ability to achieve above average growth. Our current preferences include: Corporate Travel, ResMed, and ALS Limited.