Bad Earnings: Warning Signs

To learn more about microcap strategies or the Rivemont MicroCap Fund, check out this post and see the disclaimer at the bottom.

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As investors, it's almost impossible to avoid negative earnings surprises from time to time. This is especially true in microcaps, where companies are immature and less diversified in terms of products or customer base. Sometimes, one large order can make or break a quarter, depending on when it hits.

We've all felt that heart-sinking feeling when we open an earnings press release and immediately know it will be a disaster.

Companies will do anything they can to soften the blow. However, they often lose credibility. I understand why they want to make it appear that the performance isn't that bad, but I have way more respect for a management team that admits to a lousy performance and talks straightforwardly about it.

To company executives reading this, here's what you SHOULD NOT do:

1. File results and a vague press release late on Friday night, hoping nobody will notice.

2. File the financials on SEDAR without any press release, hoping nobody will notice.

3. File the financials and issue a press release about some supposedly positive unrelated news, hoping investors will focus on the latter and forget about the results.

4. Start your press release (or even title your press release) by highlighting some cherry-picked metric that's up for the quarter. "Company X reports record gross margin % for the nine months ended September 30, 2023." Investors immediately know that your three-month results are horrible and revenues are likely down.

5. Issue a press release about your financials, but only include bullish management comments about future prospects without mentioning any numbers. It's not like investors won't go to SEDAR to look at numbers.

6. Start a press release by talking about your latest pivot and all the reasons why investors should not care too much about this quarter's results.

7. Start your press release by mentioning the positive outlook for the year's second half. Companies going through tough times are always six months away from turning around. Everybody knows that. *wink wink*

For investors, it can be hard to foresee a lousy quarter coming. Throughout the years, I've identified a few reliable patterns that tilt the odds in favour of a negative earnings surprise:

1. Bad quarters are rarely one-offs. If last quarter was disappointing, your base case should be that another one is coming.

2. Companies (whether listed on the TSX or venture exchanges) have 45 to 60 days after a quarter ends to report financials. If a company hurries to raise capital during that window, it generally means that the quarter will be bad. Otherwise, they'd hurry to get the financials out and raise the money after a strong quarter.

3. Conversely, if a company that burns capital and has a weak balance sheet should raise capital (or would reasonably be expected to raise capital) but doesn't, it can mean two things. Either the quarter was solid, or they're in deep trouble and presumably can't raise capital at any reasonable terms. The latter is often the case, from my experience.

4. Most venture-listed (TSX-V or CSE) companies that report on the last day before the deadline have horrible financials. Remember that I skim through all the press releases on the Canadian market every day, and there is always a flood of regulatory filings on the last reporting day of any quarter (upwards of a thousand per day). I can tell you it's extremely rare to see upside surprises on that last day. Companies with positive numbers typically rush to report them ASAP.

As we're approaching the end of this Q2 earnings season, I hope these tips can help you avoid painful losses or identify which management teams are worthy of your precious capital!

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Disclaimer

This publication is for informational purposes only. Nothing produced under the Stocks & Stones brand should be construed as investment advice or recommendations. Mathieu Martin, the author, is employed as a Portfolio Manager with Rivemont Investments. This publication only represents Mathieu Martin’s own opinions and not those of Rivemont.

You can learn more about microcap strategies or the Rivemont MicroCap Fund here.