Third Quarter 2020 Earnings Could Blow-Up the Stock Market…Here's How to Invest
Research has proven that volatility increases around earnings announcements and up to half of the year’s total stock market returns are produced around the handful of months companies are reporting those profits.
That’s during normal years and you know 2020 has been anything but normal! We’re coming up on third quarter earnings and it could be a game changer for stocks.
That’s why for this video, I dug through the stocks I watch and other research to find the five stocks to buy before earnings. We’ll start by reviewing where the market stands heading into third quarter earnings. Then I’ll show you the three sectors I’m watching for potentially huge, market-moving surprises and then reveal those five stocks to buy.
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2020 is All About Earnings Season
Nation, the market boomed after second quarter earnings proved the economic rebound. Stocks in the S&P 500 were up 15% in the two months after earnings started and the tech-heavy Nasdaq jumped 20% before falling into September’s weakness.
84% of the companies in the S&P beat expectations for earnings with some sectors doing even better. More than nine-in-ten companies in the IT, materials, health care and industrial sectors reported second quarter earnings above analyst expectations. Just three in 100 tech companies failed to meet or beat earnings estimates.
But the big question mark is whether third quarter earnings will be as positive. Most economic data has stalled since June with that summer jump in COVID cases. Economic data shows OpenTable restaurant reservation data still down 40% compared to last year. Retail store traffic is down between ten- and 20% and all of these have just stagnated since mid-year.
3rd Quarter Earnings Expectations
Wall Street analysts expect companies to report a decline of 21% in earnings when Q3 reports start this week. That would be the second largest year-over-year decline in earnings since the second quarter of 2009.
Worse still is the uncertainty. A record number of companies have pulled their guidance this year so we really don’t know what companies are going to report.
Looking back at second quarter surprises, nearly three-in-ten companies in the real estate and energy sectors surprised to the downside, missing profit expectations.
But there is still an opportunity to find stocks to buy for positive surprises. Nearly 50 companies in the S&P 500 have issued positive guidance, meaning they’ve pre-released some information that points to higher-than-expected earnings.
I’ll be using the Webull app to show you how to find earnings information for stocks including past surprises and when the company reports its next earnings.
I’ll show you how to use the app to find earnings data and surprises on each stock. Click through the link below and Webull is going to give you a free share of stock worth up to $1,600 when you make your first deposit.
How to Find Stocks for Third Quarter Earnings Surprises
Now I want to look at the big picture first before we get to those five stocks to buy. We’ll look at how to find stocks for earnings surprises and the sectors I’m watching right now.
And when we’re talking about earnings surprises, being able to beat those expectations for profits, a lot of time we’re talking about value stocks. Those stocks trading cheaply and asking yourself, where is the market wrong on earnings and stock valuations?
So it’s helpful to look at the sectors of the economy, their valuations and where analysts think the greatest value is going to be over the next 12 months. This is a chart from FactSet on sector valuations I like to look at and here you see in dark blue, the price-to-earnings ratio for the stocks in each sector; so technology, consumer discretionary, utilities and so on. This is how expensive stocks are trading right now versus analyst expectations for earnings over the next year.
In green, you see the 10-year average PE ratio for each sector and the first thing that jumps out is how expensive stocks look compared to that long-term average. I’ve added the percent a few of the sectors are over that long-term. For example, stocks in the market index, the S&P 500 are trading at 21.6-times forward earnings. That’s a premium of 39% over the 10-year average of 15.5-times earnings.
And some sectors are just undeniably expensive. Stocks in the consumer discretionary sector are trading at nearly double their long-run average. Tech stocks are trading for prices that are 66% higher than that 10-year average.
But if you look to the right of the graph, you see a few sectors that aren’t ridiculously expensive still. Healthcare and Financials are both trading within about 10% of that long-term average. Profits on energy companies have fallen so far that the sector has negative earnings and no PE ratio.
So for those third quarter surprises, I’m going to be looking in these three sectors for potential stocks to buy; in energy, healthcare and financials.
How to Invest before 3Q 2020
Starting with financials and two stocks I’m watching. The sector has really been hit from different angles this year. First the economic weakness has scared banks into cash protection, so they’re shifting earnings to the loan loss provision account and dialing back on lending. Second, the flat yield curve with long-term rates not much higher than short-term, means it’s really tough making money lending when you’re paying those short rates and lending on 15- or 30-year terms.
Voya Financial, ticker VOYA, is a $6 billion services company providing investment, insurance and retirement solutions.
If we click on Financials here in the menu, we see the company missed earnings pretty badly last quarter. Earnings per share were about 80% below expectations due to a $93 million hit to the Individual Life segment it’s selling. Before last quarter, the company had done pretty well meeting expectations.
We also see here, the company is expected to report earnings sometime around the third of November, expected to post $1.32 per share.
If we scroll down further, we can see expectations and earnings reported for the last four quarters and you see that bad bump last quarter.
Analysts downgraded their expectations for Q3 to $1.32 per share and I think they may have gone too far. Investment management fees were up 7% and retirement fees up 10% over the past year to the second quarter so most of the business was running well.
Besides just better financials coming through in the third quarter report, an update to the planned sell of the Individual Life business could spark a rally in the shares with the sale expected to bring in $1.5 billion plus cost savings.
Analysts have an average target of $61 per share or about a 24% upside to the shares from here.
Huntington Bancshares, ticker HBAN, is a small regional bank with branches across eight midwestern states. It beat earnings by a wide margin last quarter, posting $0.13 per share in profits against expectations for just $0.04 per share, though its track record for earnings is a little spotty. It missed expectations in the fourth and first quarter but beat again in the third quarter of last year.
Like all banks, earnings are expected to fall off a cliff this year, about half of where they were last year but I think there’s a lot of reasons to be bullish on the sector.
Shares of Huntington are down 33% this year but pay a 6.3% dividend yield. The acquisition of FirstMerit in 2016 gave it better scale and the investment bank HSE acquisition in 2018 gave it some great capital markets exposure. This growth has really helped it improve profitability and cross-sell its products.
The bank increased its loan loss reserves to $1.7 billion last quarter from just $800 million last year. Remember, that’s the cash account the banks hold to cover for higher loan defaults in a recession but the way the economy is going, I don’t think it’s going to need to add much more to the account so it won’t weigh on earnings like it has over the past two quarters.
Shares trade for just 0.91-times book value versus a history around 1.4-times book, so basically a 35% discount on the fair value.
Analysts have price targets ranging from $10 a share on the low end to as high as $12 each over the next year.
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In the healthcare space, a lot of stocks have been hit as the world shifts to a singular focus on COVID. Elective surgeries and other procedures have been all but cancelled and even pharmaceutical sales have been sluggish.
There are a lot of good names here but I’m going with CVS Health, ticker CVS, for my earnings surprise pick in healthcare.
The company has a history of beating expectations and blew by estimates last quarter by 37%, reporting $2.64 instead of the $1.93 Wall Street was expecting. Expectations for the third quarter, which should be out on November 6th, are subdued to say the least.
Analysts are expecting earnings of just $1.32 per share versus $1.84 reported last year and the company should have no problem beating this.
Despite the lower expectations for Q3, CVS is expected to report $7.23 in per share earnings for the year, up 2% from last year and an interesting disconnect for a stock that’s down 20% this year.
Just as important as Q3 earnings, I’m expecting management to provide an upside outlook to future sales around the COVID vaccine distribution, something I think could really juice the top-line here. That along with a super-cheap valuation at just 10-times earnings and I think this one could get a quick pop.
Analysts have price targets from $72 a share on the low end to as high as $104 each over the next year so even that low target is 20% higher from here.
The third sector I’m watching is energy and this is a question of ‘less bad’ for earnings because the environment really hasn’t improved much. Demand is still weak but it looks like production is coming down faster than expected so that might support prices. The hope here is that earnings show companies are more aggressive at cost cutting so profits are less negative than expected.
One of the few oil companies to remain profitable here, Diamondback Energy, ticker FANG, is a $4.6 billion explorer in the Permian basin with 1.1 billion barrels of proven reserves.
The company beat expectations last quarter to report $0.15 per share versus estimates for just $0.02 in per share earnings. It’s beaten in three of the last four quarters and is scheduled to report Q3 on November third.
Expectations for this quarter have come down to just $0.45 per share versus last year’s profit of $1.47 per share and I think there’s a great chance the company beats by a wide margin.
Diamondback has aggressively cut rigs to bring costs down and protect cash flow. Capital spending is down 35% from its original 2020 plan and operating costs are looking really good. Management reported cash operating costs of just $8.16 per barrel in the second quarter, which was among the lowest in the industry. Those costs came down 20% in the second quarter alone and should help to beat this quarter as well.
The lower costs have helped management commit to its $1.50 per share dividend for a 5% yield and the company is one of the best positioned for an eventual rebound in oil prices.
Wall Street analysts have price targets from $44 per share to as high as $72 each, so another stock where even the lowest target is well above the current price.
EOG Resources, ticker EOG, is another producer play though larger than Diamondback with a $21 billion market cap and 3.3 billion barrels of proven reserves.
The company missed expectations last quarter, reporting a loss of $0.23 per share against estimate for a $0.05 loss per share. It also missed in Q1 so the track record here is less certain.
Still the expectations for Q3 earnings are for just $0.09 per share in profits versus $1.13 reported last year so drastically lower and maybe low enough to allow management to beat estimates easily.
You can see how bad the earnings revisions have come down here comparing estimates for $0.65 per share this year against $4.98 in per share profits reported last year. It’s an 87% drop and tells you why shares are down 59% this year.
Still, the company has the cash flow to maintain its 4.2% dividend yield and shares are priced perfectly for a long-term rebound. Cash operating costs last year were down to $8.76 per barrel, so a little higher than Diamondback but still among the lowest in the industry and the company has some premium assets in shale oil that should be unlocked when prices recover.
Analyst targets range from $52 per share to as high as $85 each for a potential return of 132% over the next year.
Don't let the stock market begin earnings season without checking out these stocks. The majority of your returns are directly tied to earnings reports and the third quarter of 2020 could be a game-changer. Are you positioned for it?