The Perfect Earnings-Season Stock: Unloved, and Without Guidance

(Bloomberg) -- People predicted a strange earnings season. They're getting it.

With a majority of companies having reporting results, a composite is starting to emerge in the market as to what kind of stock investors are embracing. Two unexpected preferences that have surfaced over the last three weeks are for firms that withdrew their guidance, and for those that fund managers shun.

The possibility that counterintuitive themes -- even bizarre ones -- would emerge as results rolled in from Corporate America in the age of coronavirus was a reason many active managers expected to thrive during the stretch. Whether they managed to get in front of these particular trends remains to be seen, but it's making for interesting trading.

“This has been a weird earnings season, to say the least,” said Paul Nolte, a portfolio manager at Kingsview Investment Management in Chicago. “It's hard to wrap your head around what's going to happen and how companies are going come out of this. Who's going to be the winner and who's going to lose? There's no consensus.”

Everyone knows companies are abandoning sales and earnings forecasts in droves. Turns out, doing so has boded well for their stocks. So far, 114 S&P 500 members have suspended guidance, data compiled by Bank of America show. In the five days after doing so, they've outperformed the S&P 500 by 46 basis points, according to the bank's data.

That's “despite the fact that guiders have historically traded at a premium to non-guiders,” Bank of America strategists including Savita Subramanian noted.

It kind of makes sense, says JJ Kinahan, the chief market strategist at TD Ameritrade. Investors are willing to forgive a fair amount of uncertainty when they are flying blind on the economy. Whereas when companies specify, they establish thresholds that the market immediately becomes dubious of.

“When a company says, ‘We don't know, we're leaving it to you to try and decide,' people often tend to be a little more optimistic,” Kinahan said. “Those that are putting hard numbers to it, you have an opportunity as an investor to say, ‘There's no way I believe in those numbers.' And so you can say they can't possibly beat those and either sell the stock or not buy the stock with as much enthusiasm.”

Of course, once a company says it's not sure how it will do, imaginations run wild on Wall Street. Bank of America data show that guidance suspenders have seen analysts cut next year's earnings estimates by 10%, compared with a 7% drop for the S&P in general.

Over the last few weeks, traditional hallmarks of earnings-season success, namely posting income or sales that beat analyst projections, have had variable and middling impact on share prices. That's understandable, considering the unreliability of estimates. A better determinant has simply been to look at a company's ownership structure. In short, if a stock scored high on measures of “crowdedness,” or how loved it was among fund managers, it has tended to get punished after reporting.

To date, crowded stocks have trailed the S&P by 1.1 percentage points after a profit miss and got no advantage over the market after a beat, data compiled by Bernstein Research show. Less popular names have moved more than the market when they both beat and missed earnings estimates, by 3.4 and 1.8 percentage points, respectively.

“This aptly captures crowding risk, because crowding is the result of elevated sentiment,” said Ann Larson, head of U.S. Quantitative Research at Bernstein Research. Incremental positive news “tends to be of little benefit, as there is little room left to improve already excessive expectations.”

More than 280 S&P 500 companies have reported their first-quarter results so far. On a sector basis, there's been a notable disparity in results. Tech megacaps and non-cyclicals have posted an earnings advance of 7% and 4%, respectively, data compiled by Credit Suisse show, while financials and cyclical firms saw their EPS contract by at least 37%.

“People are trading based on what they think will happen a year from now,” said Donald Selkin, chief market strategist at Newbridge Securities Corp. “It's the anticipation, people are trying to guess what earnings are going to look like a year out or so. It's people's best estimate. It's impossible to model estimates for the near-term.”