Welcome to the inaugural installment of MGONE’s Monthly Journal, where followers of MarketGrader’s flagship U.S. index may learn more about its constituents, the factors impacting its performance and the implications these may have for U.S. equity investors in general.
July started out as one of this year’s strongest months, with MGONE up almost 4% by July 20, before giving up almost half of its gains by month’s end—as investors weighed the likelihood that escalating trade tensions between the U.S. and China might derail an otherwise stellar performance for the U.S. economy in the year’s first half. Contrary to what had been a pattern of smaller companies outperforming large ones so far this year, these late-July jitters had a much bigger impact on small caps than on large caps, with MGONE lagging the S&P 500 for the month by 186 basis points1. MGONE thus ended the month with a price-return of 1.74%, even though the number of stocks that closed the month in the black outnumbered those that closed in the red by a ratio of almost 2-to-1 (58 positive to 30 negative).
As is usually the case with the financially sound members of MGONE, a close look at the fundamentals paints a different picture from what their short-term returns might otherwise suggest and helps illustrate Ben Graham’s adage that while the market is a voting machine in the short run, in the long run it is a weighing machine. To wit, 47 companies in MGONE reported second quarter earnings during the month of July, with 35 of them beating their consensus analyst estimate and only eight missing it; meanwhile, four companies reported exactly as predicted by the analysts tracking them. Yet, despite such evident underlying profit strength, 16 of the companies that reported earnings last month had a negative price return. Overall, these 47 companies had an average price return for the month of 2.1%. The five biggest positive and negative earnings surprises are illustrated in Figure 1.
Figure 1. Five Largest Positive and Negative Earnings Surprises Among MGONE Constituents Reported in July 2018
|Ticker||Name||Industry||Market Cap||Overall Grade||Earnings Surprise|
|Largest Positive Earnings Surprises|
|AMBM||ABIOMED||Medical Specialties||$19.1 billion||66.6||144%|
|TNET||TriNet Group||Data Processing Services||$3.9 billion||56.3||30%|
|ALSN||Allison Transmission Holdings||Trucks/Construction/Farm Machinery||$5.7 billion||77.8||29%|
|CSGP||CoStar Group||Internet Software/Services||$15.5 billion||67.1||27%|
|AXTI||AXT, Inc.||Electronic Production Equipment||$335 million||65.8||25%|
|Largest Negative Earnings Surprises|
|EQM||EQT Midstream Partners||Oil & Gas Pipelines||$4.7 billion||74.8||-18%|
|MHK||Mohawk Industries, Inc.||Home Furnishings||$16.7 billion||60.2||-10%|
|AEIS||Advanced Energy Industries||Electronic Production Equipment||$2.4 billion||79.0||-7.4%|
|FELE||Franklin Electric Co., Inc.||Industrial Machinery||$2.1 billion||61.5||-7.1%|
|LVS||Las Vegas Sands Corp.||Casinos/Gaming||$58.8 billion||60.3||-6.3%|
More important than the magnitude of earnings surprises, however, was the remarkable strength in earnings growth reported by most of the 47 companies that reported earnings last month. Among them, 39 reported double-digit increases in earnings per share compared to their reports a year earlier while only two companies reported negative earnings growth: Mohawk Industries (MHK) and EQT Midstream Partners LP (EQM). Four companies, ABIOMED (ABMD), Allison Transmission Holding (ALSN), TRI Pointe Group (TPH) and AXT, Inc. (AXTI) more than double their per-share earnings in the last year.
Notably, all companies in the Financials sector that reported results last month recorded a double-digit increase in earnings per share, with the smallest gain reported by Lakeland Bancorp, whose profits rose 17.9% year-over-year. A total of 15 companies in the Financials sector—12 of which are Regional Banks—reported an average jump in earnings per share from a year earlier of 34%, underscoring the strength in the U.S. economy, which grew last quarter at an annualized rate of 4.1%, the fastest in more than four years.
We can think of no clearer illustration of how differently investors behave in the short and long-term than by looking at the fortunes of the stocks in MGONE that reported earnings last month following those reports. While, on average, they reported earnings that beat consensus estimates by 8.3%, with a median surprise of 3.1%, their shares declined by an average of -0.3% from the day before to the day after their announcement; this helps to underscore how market-wide factors (size, in this case) tend to affect stocks in the near term irrespective of fundamentals. Over time, though, as followers of MGONE understand, fundamentals drive stock returns, usually rewarding strong fundamental performers such as the constituents of the MarketGrader 100 Index.
Appendix – Summary of Price Returns for MGONE Through July 31, 2018
|Index||July 2018||Year To Date||52-Weeks|