For years, investors have been putting up with profitless companies. Paying up for them, too. Why worry about a nosebleed valuation when the future looks so fabulous?
Now, that line of thought is being questioned. Patience that used to be boundless is starting to wear thin.
"We're looking at the future and saying 'We want to buy into the new world,'" said Kim Forrest, chief investment officer at Bokeh Capital Management in Pittsburgh. "But the new world isn't profitable right now."
It started with the implosion of WeWork, then spread to software shares as investors got sick of throwing cash at expensive stocks. More than a third of the way through earnings season, a theme is going viral, its logic stark. Post profits and get rewarded. Flub and get punished. Your community-adjusted eyeball counts impress nobody.
"WeWork brought people to their senses," Chris Gaffney, president of world markets at TIAA, said by phone. "That 'Hey, we need to see companies making money and having earnings in order to really justify some of the numbers that are out there."'
Among companies, metrics that used to steal the spotlight as indicators of future growth are being ignored, particularly in tech. In its place is a focus on the top and bottom lines.
Take Twitter Inc., for example. Normally, investors looked for growth signals in the social media company's earnings reports, primarily through new user additions. In the third quarter, Twitter added 6 million active users for a total of 145 million, a 17% increase from a year earlier. That was a bright spot, and in past periods may have been rewarded.
But the social media site also delivered earnings and sales that fell short of analyst expectations, plus a weak revenue forecast for the period ending in December. Shares fell as much as 20%, the worst day since July 2018, when Twitter reported a drop in active users and predicted further declines.
Snap Inc. is another casualty. The company, which lets people send video and picture messages that disappear, has yet to turn a profit since its 2017 initial public offering, but its stock has more than doubled this year, mostly on optimism that subscriber growth will eventually filter through to the bottom line.
While its Snapchat application beat estimates for daily active users, the stock fell almost 6% after third-quarter results showed its path to profitability is still a work in progress. Investors blanched at Snap's revenue outlook for the fourth quarter, which at the midpoint came in below analysts' expectations.
The opposite was true for Elon Musk's Tesla Inc. Analysts who had expected a decline in profits were proved wrong when the company reported adjusted earnings per share of $1.86, the third-largest in its public history. Shares soared as much as 20%, its best day in six years at the highs.
A similar dynamic buttressed ServiceNow Inc. Shares of the software-maker fell in the middle of last week partly because of a slight miss on subscription billings forecast. But when the company released its full results after the bell, including earnings that beat the highest analyst estimate, the stock jumped more than 7%.
The intense focus on bottom-line metrics may be tied to another trend, extreme valuations for putative growth companies that aren't actually growing that much.
Consider value companies in the Russell 1000, those chosen for their low price-earnings or price-to-sales characteristics. As a group, they've expanded income faster than their growth brethren over the past year, notes Michael Wilson, Morgan Stanley's chief U.S. equity strategist. And yet, based on forward earnings, the valuation gulf between the two groups is roughly the widest since the dot-com bubble. If bulls aren't getting the growth they're paying for, it follows that they'd get stricter with the shares.
"Investors are still piled into growth names, hoping the earnings growth picture improves," Wilson wrote in a note this month. "However, both the last twelve-month and next twelve-month numbers suggest that growth's earnings superiority is on hold for now."
The market has been unforgiving of failure in general. In the 24 hours after reporting, firms that have missed earnings expectations have seen their shares fall 2.4%, according to data compiled by Wells Fargo. Those that beat have risen an average 1.6%.
None of this is good news for this year's marquee initial public offerings, including ride-sharing companies Lyft Inc. and Uber Technologies Inc., or even alternative meat company Beyond Meat Inc. The newly public companies have yet to generate positive earnings, and each of them still have to report for the last quarter.
Executives at Lyft, already staring at stock price that's fallen 40% this year, may be looking to get ahead of any disappointment. Last week, the company's founders announced that it would turn a profit by the end of 2021, focusing on earnings growth rather than scale at all costs. Investors' ears perked up, sending shares to one of their best days on record.
"People want growth, but they want growth to have profits attached," Malcolm Polley, who oversees more than $1 billion as chief investment officer of Stewart Capital Advisors LLC in Indiana, Pa., said by phone. "The market is realizing, 'Look. We need to get payback on our investments eventually.'"
Information for this article was contributed by Luke Kawa, Vildana Hajric and Jeran Wittenstein of Bloomberg News.
SundayMonday Business on 10/27/2019