A Glimpse at Small Cap Estimate Revisions

Our philosophy regarding equities is based in large part on the notion that prices reflect investors’ beliefs regarding expectations of future earnings. When those expectations change, prices move in response to the new sentiment. With constantly changing information, even well-informed investors face difficulties identifying the relevant signals on numerous stocks simultaneously. Another cornerstone of our philosophy is that investors rely on perceived experts when making decisions. In the case of equities, those experts are often sell-side analysts. What those analysts say about the companies they cover can significantly impact prices. Even more powerful, is what they expect in terms of future earnings. Our quantitative models rely heavily on these data points. Naturally, we care a great deal about estimate changes.

As we are now in full swing of 3Q17 earnings season, we provide a glimpse of various sectors and industry groups in the small cap universe, and see how they have been trending since the beginning of 2016. To note, at 361 Capital, we separate certain homogenous industry groups into their own sector and combine with the GICS sectors to form 18 “361 Sectors” (as opposed to the 11 GICS sectors).  Each month end we measure the percentage of positive current and next fiscal year earnings in the aggregate for each grouping. (All charts below are created by 361 Capital with data from S&P Global ClariFI.)

Among Financials, Bank stocks have had the highest percentage of net positive analyst revisions (56%) during this period. Expectations rose going into, and shortly after, the presidential election, but have trended down since March. Non-bank Financials have trailed the Banks since the beginning of 2016 with 43% net positive revisions over the timeframe. For the month-ending September 30, estimates for non-bank Financials were the most negative since last July, but have since rebounded in October.

Despite presidential tweets railing against the cost of prescription drugs, estimates for small cap Pharmaceuticals & Bio Tech stocks have remained fairly stable. The group’s month-to-date percentage of 53% is currently among the highest. Conversely, the rest of the Health Care sector (which we call Healthcare Equipment) has experienced a noticeable drop in the percentage of positive revisions. Only about a third of revisions (34%) were positive as of October 24th. This is the lowest percentage for Healthcare Equipment over this span and the steepest drop of all groups in the latest period. Whether or not this decoupling will continue is something to watch.

Information Technology also has interesting dynamics among the three major sectors, as we categorize them. It may be simple to think that the sector is largely correlated, but there are obviously diverse businesses and differing cycles within each sector. Semiconductors and Software (55% each) have had the second- and third-best positive revisions over the last 21 months. The positive percentage range has been narrower for Software, with a low of 42% at the beginning of 2016 to a high of 67% at the end of September. Monthly Semiconductor revisions have fluctuated more widely. Semiconductors had the largest increase in net positive estimate revisions in the most recent period ending October 24th, slightly surpassing Tech Hardware’s positive uptick.

The Retail group had the weakest revisions, with only 38% net positive revisions during the period. The trend has been somewhat stable, though, with typical fluctuations. There may even be some burgeoning optimism within the group as the last six of seven months since March have seen a higher percentage of positive revisions compared to the entire 21-month period. Analysts do not seem to think that Consumers are completely putting their wallets away though. Durable Goods’ percentage of positive revisions were the fourth-highest since the beginning of 2016 and also for the most recent reading in October.

Many of the Russell 2000 constituents will be announcing financial results over the next few weeks. Earnings estimates are sure to evolve as analysts digest new information. Whatever the direction among the sectors and industry groups as a whole, our behavioral models incorporate each estimate and identify those securities believed to be beneficiaries of those changing expectations.

Happy earnings season.

Read more in our Q3 Wall Street Mood MonitorTM