Are Optimists Prime? No! Quite The Opposite

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Graham Copley / Nick Lipinski

203.901.1629/203.989.0412

gcopley@/nlipinski@ssrllc.com

May 17th, 2018

Are Optimists Prime? No! Quite The Opposite

  • We are revisiting the optimism work that we began in 2012, with no expectation of finding different results and consequently no disappointments.
    • Optimists still limit shareholder value creation relative to their more conservative cousins (Exhibit 1) and are still as easy to identify.
    • Some of the players have changed – in most cases, as we predicted in prior versions of this report, coincident with regime, or more dramatic change.
  • We have a group of 85 Industrials & Materials companies of all cap ranges with sufficient estimate and EPS history back to 2002 (the base year for our initial 10-year analysis published in 2012).
    • The constituents of both the good and bad groups have changed – in part because of transactions, but there have been some deteriorations and improvements.
  • With several more years of data incorporated, changes in the composition of the optimist and conservative groups are summarized in Exhibits 7 and 8.
    • Several have been bought out or split; several others are new coverage additions as we have expanded our SMID universe over the past several years.
    • Notable companies that were in the top 20 conservative (investable) group in our original 2012 work that have fallen out of this group include BLL, ETN, SLGN, and VMI.
    • There are fewer examples of companies improving enough to fall out of the optimist (negative) group: only EME because of improvement.
  • Otherwise we look for the those with the most improving trends or deteriorating trends – whether or not they make into the top or bottom quintiles – or the top or bottom 20.
    • There are fewer improvers than those falling – improvers include PKG, GLT and MTX
    • Those going most rapidly backwards are: TKR, RS and CMI – Exhibit 6.

Exhibit 1

Source: Capital IQ and SSR Analysis

Overview of Methodology

To review, we attempt to quantify corporate “optimism” by comparing the difference between actual EPS in each year with the estimate on January 1st of that year – Exhibit 2 demonstrates this using NSC as an example. The key assumption for this methodology is that estimates reflect corporate guidance. Any given year may be an anomaly, but persistently optimistic companies underperform and destroy value as shown in Exhibit 1.

Exhibit 2

Source: Capital IQ and SSR Analysis

All things being equal – industry dynamics, valuation, capital structure etc. – we would always favor a conservatively managed company over an optimist.

Results

Exhibit 3 shows the current 20 most optimistic and 20 least optimistic (most conservative) companies on this measure. As noted above, we have a sample set of 85 Industrials & Materials companies of all cap ranges that have earnings and estimate history back to 2002 (our initial optimism analysis considered a 10-year period from 2002-2011).

Exhibits 4 and 5 summarize the key takeaways from this analysis. In Exhibit 4, the divergent return on capital trends suggest that the optimism embedded in earnings guidance/estimates can often extend to a company’s capital allocation decisions – optimists deploy capital with overly aggressive assumptions and fail to achieve appropriate returns.

Exhibit 3

Source: Capital IQ and SSR Analysis

Exhibit 4

Source: Capital IQ and SSR Analysis

Exhibit 5

Source: Capital IQ and SSR Analysis

In Exhibit 6, we show the ten stocks with the biggest positive and negative changes in optimism compared to the results through 2011. There is a bit of a mean reversion effect here, with many historical optimists seeing improved results relative to their past and many historically conservative companies seeing deteriorations.

Exhibit 6

Source: Capital IQ and SSR Analysis

Exhibits 7 and 8 show the constituents of the 20 most/least optimistic companies from our initial optimism analysis in 2012, and track the developments in each company’s optimism since that time.

Exhibit 

Source: Capital IQ and SSR Analysis

Exhibit 8

Source: Capital IQ and SSR Analysis

©2018, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. Sources: Capital IQ, Bloomberg, Government Publications.

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