INSIGHTS BLOG

THE IMPORTANCE OF MARKET EXPECTATIONS

Roy Davidson, 29 January 2019

Last Friday two Australian companies provided updates to the market.

The first was ResMed, the market leader in treatments for sleep apnoea, a disease characterised by excessive snoring and interrupted sleep. ResMed reported a solid result with revenues lifting 9% and good operating performance continuing, especially in the key US market. Shares in the company ended the day down 12%.

Meanwhile AMP, the under fire wealth manager and insurer, revealed it expects to report a significantly lower profit number when it reports in February. The company also announced a 72% cut to its final dividend. Shares in AMP ended the day down a relatively paltry 7%.

What gives? How can one company report a decent result and see its shares hit harder than a company slashing its dividend.

The answer lies in market expectations. Or, what is being priced into each company’s share price by the market.

In ResMed’s case, shares had performed exceedingly well after a string of superb results. ResMed has been gaining share in its core sleep apnoea and venturing successfully into new ones. After such as run, investors were expecting a standout result and positive commentary from the company.

When the result was merely a solid one and management discussed the extra investment it intends to undertake in new areas of the business (thereby limiting near-term earnings growth), investors were disappointed, and Resmed shares were sold off heavily.

On the other hand, AMP has been hit hard by the fallout from Australia’s Royal Commission into financial services misconduct. Both the CEO and Chair of the Board have departed, the company has announced various provisions and write-downs, and bungled the sale of its troublesome life insurance business.

Sentiment was at very low levels, so when the company announced yet another downgrade and even took the rare step of slashing its dividend, investors weren’t particularly surprised. While the cut to the dividend was more aggressive than expected, shares in AMP still held up better than those in ResMed.

This highlights how important it is to understand market expectations, and how other investors are positioned.

While we take a long-term approach to investing, focusing on the fundamentals and trying not to get too distracted by short-term fluctuations, we must also consider what other investors are expecting.

This can help us identify attractive entry points in companies that have fallen out of favour with the market, but which we believe still have an attractive long-term outlook. When expectations are low, even a modest improvement in performance can be rewarded by the market. On the other side of the coin, when expectations are running high and shares are priced to perfection, the market can react severely to any bad news.

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