Profit Warnings Are Everywhere – Should I Worry?

Coded
Language

Let’s
start
with
the
basics.

The
words
“profit
warning”
are
rarely
found
on
stock
exchange
announcements
because
companies
don’t
want
to
deliver
bad
news
to
investors.
When
they
do
they
tend
to
use
euphemisms.
This
week’s
example,
advertising
challenger
S4
Capital,
lost
22%
of
its
value
in
one
day
after
warning
on
profits
and
releasing
loss-making
figures
for
the
half
year.

“Following
slower-than-expected
trading
over
the
summer
months,
including
August
and
current
client
activity
levels,

full
year
expectations
have
been
revised
further,”
the
company
said
(author’s
emphasis).

Effectively,
at
the
halfway
point
in
the
financial
year,
S4
Capital
said
its
revenues
will
be
lower
than
anticipated,
as
will
“operational
EBITDA”,
a
measure
of
profitability.
Investors
are
being
told
here
that
revenue
and
profits
will
fall
short
of
expectations.
So
this
was
a

revenue
warning.
Media
reports
bundled
this
double
bad
news
as
“profit
warning” –
an
easy-to-understand
shortcut
for
investors.

Often
sales
and
revenue
fall
in
lockstep
together,
by
the
very
nature
of
how
companies
make
(or
lose)
money. Another
recent
example
is
housebuilder
Redrow,
which
also
“guided”
for
lower
sales
and
profits
for
the
full
financial
year.

EY
Parthenon,
which
has
been
monitoring
profit
warnings
since
1999,
defines
them
thus:
“a
profit
warning
is
an
official
statement
to
the
stock
exchange
from
a
publicly-listed
company
that
says
that
it
will
report
full-year
profits
materially
below
management
or
market
expectations.”

Like
Buses,
But
Why?

Not
all
profit
warnings
are
equal.
Just
as
bad
news
tends
to
be
cumulative,
so
it
appears
do
profit
warnings:
some
companies
are
serial
“warners”
and
are
treated
differently
by
the
stock
market.
Fast
fashion
chain
ASOS
(ASC)
is
a
familiar
such
company:
the
first
of
two
last
year,
on
June
16,
pushed
shares
down
20%.
There
was
another
one
in
September
that
year
and
that
followed
warnings
in
2021,
and
2019.
Morningstar
analysts
now
think
ASOS
shares
are
significantly
undervalued.
They
are
currently
priced
at
£3.92.

Do
profit
warnings
attract
more
profit
warnings?
It
certainly
seems
to
be
the
case.
But
an
unexpected
profit
warning
from
a
previously-star
stock
can
also
unsettle
investors
as
much
as
a
serial
warner.
Even
Apple,
which
was
the
first
firm
to
reach
a
valuation
of
$3
trillion
(£2.4
trillion),
warned
on
profits
in
2019,
a
mere
17
years
after
a
previous
warning.
It
can
happen
to
the
best
of
companies
too.

To
get
back
to
first
principles,
it
might
be
worth
asking
why
they
occur?

Clearly
there’s
a
mismatch
here
between
what
investors
expect
to
happen
and
the
guidance
companies
are
giving.
Part
of
this
is
down
to
the
nature
of
quarterly
and
half-yearly
reporting,
a
state
of
affairs
demanded
by
investors
and
one
that
keeps
public
relations
specialists
and
journalists
busy
four
times
a
year.

Accounting
is
also
inherently
backward-looking,
and
a
lot
can
change
in
between
preparing
and
presenting
results.
Like
all
financial
forecasts,
earnings
predictions
are
based
on
extrapolations
and
assumptions
that
can
change
dramatically.
In
recent
years
companies
have
blamed
a
“deteriorating
macro
environment”,
amid
a
global
pandemic,
industry
slowdowns,
and
spikes
in
inflation.

There’s
plenty
outside
a
company’s
control
too.
But
there’s
also
an
element
of
“over
promising”
built
into
the
reporting
by
listed
companies:
they
want
to
present
the
best-case
scenario
to
investors,
which
includes
fund
managers
who
decide
whether
to
shares
on
your
behalf!
On
the
flipside,
profit
upgrades
can
be
rewarded
too:
this
year
Rolls-Royce
shares
are
up
more
than
128%.
July
saw
a
big
leap
higher
when
it
upgraded
its
full-year
forecasts.

As
we’ve
seen
of
late,
half-year
results
can
be
a
key
moment
for
warnings.
By
then
a
company
can
roughly
tell
how
the
rest
of
the
year
is
going
to
pan
out,
and
what
has
changed
since
the
predictions
were
last
made.

Are
Markets
Efficient?

Trainee
fund
managers
and
analysts
are
taught
the
“efficient
market
hypothesis”,
which
posits
that
all
possible
(publicly
available)
information
is
priced
in
to
shares.
You
could
argue
profit
warnings
vindicate
this
idea,
that
the
market
is
adjusting
its
expectations
of
the
company
via
the
mechanism
of
the
shares.
But
for
the
company
to
be
worth,
say,
a
quarter
less
than
it
was
worth
yesterday
because
it
will
make
less
money
seems
a
stretch.

Should
companies
stop
making
forecasts?
That
could
be
one
solution
to
the
profit
warning
carousel,
and
one
that
happened
in
the
pandemic.
Firms
cited
the
uncertainty
over
the
outlook,
which
made
them
unable
to
make
forecasts
for
the
full
year. 

For
the
contrarians
among
us,
share
price
overreactions
after
profit
warnings
help
short
sellers.
You’ll
see
that
this
week
when
we
publish
our
quarterly
look

at
the
most-shorted
shares on
the
FTSE
100.
Shorting
companies
that
issue
punishing
profit
warnings
is
meat
and
drink
to
the
short
seller.

And
what
of
the
bigger
picture? According
to
EY,
in
the
second
quarter
of
2023,
profit
warnings
increased
again
on
a
year-on-year
basis,
the
longest
run
of
rises
since
the
financial
crisis.
There
are
structural
factors
at
work,
from
low
economic
growth
to
rising
debt
costs.

All
that
means
investors
will
await
the
next
earnings
season
with
greater
interest
than
ever.

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