The Dividend Cafe - Earnings Season Expectations

Episode Date: October 9, 2019

Topics discussed: As hard as it may be to focus on anything other than political drama and the China trade war, we actually have an earnings season starting next week. Listen in or watch as our Investment Committee dives into all our expectations and thoughts of the earnings season that is about to begin, and what it means for investors. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Hello, welcome to this week's Dividend Cafe podcast with our investment committee. We're doing this for the first time where we're not all in the same room together. Since we began doing these, it's my first time where I'm actually in New York City. Since we began doing these, it's my first time where I'm actually in New York City. And so I'm sitting here at my desk in New York. And there in California, we have Julian. I can see you very clearly.

Daya, I think, is right there behind you or in front of you. There you are. Okay. And then Robert is off there as well. And so, well, I think we're going to make this work. Our production team has got it all dialed in now where we can hear each other, see each other, and they edit it and make it something good for you all to view, good to listen to. But this week's topic is kind of a preview of the earnings season that we're about to go into.

As we're recording it, it's Tuesday, October the 8th. And by this time next week, earnings season will officially launch. And so what I mean by that is that we will spend about four to six weeks in the fourth quarter, where most of the companies in the S&P 500 are releasing their results from the third quarter. And all their quarter calendars are all different. You know, some of them, it may be called something different, but the point being July through September results will be announced.

And these quarterly intervals tend to be opportunities for companies to make updates in their business plan, updates in their business plan, updates in their strategic objectives, and to kind of inform shareholders some of the good, bad, and ugly going on within their companies. Oftentimes companies will announce dividend increases or stock buybacks, and oftentimes they can share bad news as well. And then we talk a lot about the concept of forward guidance,

and that essentially is sort of the third major category of what we look to get out of earnings season. Each company's earnings report will include what they did the prior quarter in terms of revenue, top line, what they did the prior quarter in terms of earnings, bottom line, and then what they're projecting going forward, whether it be revenue, earnings, different metrics in their business. And I've become much more convinced over the years that that last category, forward guidance,

tends to be what will move a stock out of their earnings announcement more than the others. Now, of course, if a company very unexpectedly blows away earnings results, that can cause a stock to rally and vice versa. It can crash if they have really unexpected bad news. But oftentimes they'll give good news and the stock will go down. And in those situations, it's always, almost always, because they guided forward in some way

that was maybe a little more negative. So that's anyways me setting the table for what we wanna discuss. We're not gonna get into any individual stock names here in this podcast. For those of you who are clients, of course, we're regularly updating you every single Wednesday in our weekly portfolio holdings report

around the very nitty gritty of what's happening regularly updating you every single Wednesday in our weekly portfolio holdings report around the very nitty gritty of what's happening in our own portfolio companies. But for today, I want our investment committee to have a conversation around our outlook for this earnings season, what we think is on the line, what we're expecting, and a number of different ramifications of all that. So with all that said, guys, that's my long setup. Sorry for the long intro. Julian, I'll start with you.

Two quarters in a row now that some earnings expectations were assumed to, the expectations were assumed to be negative, and earnings outperformed that negative assumption. That's right. Are we in for three in a row? I would bet that we are because I think there's a tendency, you know, these companies are a very professional investor relations department.

They're experts at guiding the street and what they need is they try to, you know, make sure that every time they announce results, they beat expectations. So if you look at the hit or miss ratio of companies reporting, it's always much higher than 50%. So what's likely to happen again is people have been a bit bearish with what's happening with the trade war and communication from the companies who are trying to manage expectations so that the day of the earnings report, actually they beat.

So I would guess that they're probably going to beat, but at the end of the day, it's not, as you said, what's most important because what investors are going to focus on rather than the Q3 results, if you beat, it's fine, but it's more the guidance for the next quarter for Q4. And now we're entering also the last quarter of the year.

So people are going to start asking questions about the next year outlook, you know, 2020. And that's where it's going to be tricky because there's a lot of the visibility is not great. And so you can imagine with what's happening with the trade war, companies are going to be very conservative with their guidance. So that's where, you know, even if you have results that are going to beat expectations, if the guidance is conservative, maybe, you know, it's not going to be, you know, the party we would be hoping.

Well, Dea, is that going to be true for companies that are mostly domestic in their sales too? Is what Julian's bringing up only a risk for multinationals or do you think there's domestic concerns as well? I think as far as companies where their customer base is entirely in the United States, I think that outlook is going to be different. They have less to deal with. But I mean, it's very few companies, at least the companies we own, that have absolutely no exposure to the rest of the global economy. But as far as companies that are focused on the domestic sector, I think their guidance will be different.

I think their business optimism could be different. As far as to piggyback a little off what Julian said, is that, yeah, earnings might come in better, a little better than expected, given how companies are engineered to beat expectations a little bit because they set them a little low. are engineered to beat expectations a little bit because they set them a little low. And it's possible that there might be, if you look at the wage data, wages have increased slightly, and there could be certain input costs that are starting to affect fundamentals in a minuscule way. I don't think it's going to be anything surprising, and it's really going to come down to guidance. But sure, I mean, if you compare two CEOs, one of them is the CEO of a firm that purely does business domestically, and another has 70% of their revenue is generated overseas, I think the former is going to be a bit more optimistic about the future. about the future.

Robert, do you agree with Julian's assessment? Even if we go just to the multinationals, is there a possibility that companies are going to use the trade war as an excuse to guide revenue estimates down? Do you think that there is a legitimacy in it? How would you unpack that whole point of multinational companies reporting their results and factoring in some impact from the trade war into their three and six and 12 month guidance? Well, I think Julian's absolutely spot on in his prediction that that's going to happen. I mean, there's always been a tendency to my, for these companies to predict a little less than what might actually be the case. So there's a positive surprise.

But I think going forward, it's certainly maybe prudent for them to do that even more with the trade war going on. We've seen that it's continued to be a source of uncertainty, and it doesn't seem to be abating at all. So I would agree completely with what Julian said around that. Are you also saying that if there's any other issues going on with the company that they're going to use a trade war as an, an escape goat? Is that what you, is that awesome? I don't know. I don't know that I'm saying it. I think it's worth us questioning that on two fronts,

both an optimistic one and a pessimistic one, you could have companies that guide lower forward based on uncertainty around where trade war could impact their underlying business and have it underwhelm, meaning it doesn't materialize to the magnitude that they are concerned about. And then you end up with a outperformance in a future quarter. So I think that that would be an optimistic possibility if companies do that. But then I also do think that there is a sense, particularly with some technology companies, that they have a little bit cleaner of an argument to make for where supply chain uncertainty could impact their business.

And yet I'm not totally convinced that some of them, and I know it's a little bit handcuffed that we're not going to talk individual companies, but I don't think it's necessary. I think that some of them, the trade war could give them a little cover. And I'll give you an example, Daya. How many times have we seen since late 2014 when the dollar began its kind of massive ascent,

companies report missing a few pennies on earnings and say, but if it wasn't for the impact of currency, this or that. It was almost every company. But how many times have you ever seen a company that beat earnings say when the currency went in their direction, do you the favor of pointing out where currency was a tailwind? You see my point? Yeah, close to none. Yeah. So I think that it's natural that they'd want to play things, Julian, for best ball, try to use the trade war to position for some potential disappointment, but then also hopefully outperform and you get the best of all worlds.

But let's not play psychologist with the company's CFOs right now. is the trade war going to impact, A, the Q3 results we're about to get, and B, the guidance we're going to get for future quarters? Definitely. I would say definitely. I guess if you put yourself in the shoes of the CFO, you're going to be mid-October, you have to write this report and try to guide, and you're going to say, okay, so we have these trade war discussions. We know what happens. Maybe next week they're broken again.

And then they know that there are some new tariffs coming in October, some in December. So they have to take that into account. And I don't know if you saw, I shared with the team earlier some graphs that was prepared by the IMF. The new managing director would just replace Christine Lagarde and showing the impact of trade war. And it shows how, you know,

there's an exponential, basically, impact on the economy. So, which is like, if, you know, if you don't sell it that quickly, the impact next year is going to be much worse than this year. So, I think it's... So, why is that the...

What do you mean? As far as it's... Why is it exponential? Well, because I guess of the lag into the, you know, flowing into the economy, you know, the impact of trade war first on trade and then on confidence. And then so it's just have a exponential impact as, you know, the feedback look increases the impact on the overall economy. So I guess that's where I think you have to be worried. And the other thing we haven't talked about is like, if you look at consensus for the 2020 on the S&P,

at the moment, the market on the sell side is assuming almost like 10% earning growth for 2020, which is, you know, not given, right? It's far from given if you have a trade war that's still happening next year. And less growth. I mean, IMF predicting basically growth is slowing down. We're not talking about a recession,

but there's clearly less growth around the world with the U.S. being like a safe haven at the moment. Yeah, it is tricky because when I look at the market, it's pretty uncertain to me what exactly is being priced in. I mean, do you think that obviously a trade war is not being priced in at the moment well i guess i would say i'm sure david have a strong view on that on that i would say that the we are like somewhere there's a you know one hand we have like the fed really helping accommodating and kind of balancing control balancing what's happening with trade war and slowdown in

worldwide growth. And that's why we're kind of stuck here. And if you didn't have the Fed, we would be going much lower. And if you have confirmation of recession happening, probably go lower. But now we still don't know if it's a mid-cycle adjustment

or if it's a late-cycle adjustment. In hindsight, we will know. The Fed is telling us it's a mid-cycle adjustment. They might's a late cycle adjustment we don't know in hindsight we will know the Fed is telling us it's a mid-cycle adjustment they might be right they might be wrong yeah I'll be I'll be interested to see because we've seen with the trade war that it's been incrementally threatened this and that from the administration from powers that be so I'll be interested to see the the divergence between you know the top line and the bottom line see how it's actually affecting margins for a lot of these businesses right because there haven't been too many quarters where we've you know, the top line and the bottom line. See how it's actually affecting margins for a lot of these businesses, right?

Because there haven't been too many quarters where we've actually seen real effects of price increases. David touched upon supply chain effects as well, but I think this will be interesting, especially for the tech sector. Actually, it's interesting you mentioned that because there's like, I was checking some numbers from I think Goldman Sachs was saying

that excluding financials and utilities, so they're expecting the S&P margins actually to contract by 100 bps. So they think that the top line is still going to grow, but margins are being impacted. Is that because of input costs? You look at labor costs and wage unemployment dropping down pretty significantly again. So those are all going to affect that. Yeah, because it'd be interesting to see that breakdown exactly what is attributable to, you know, to the tariffs as far as far as that margin compression goes. And it also could be, I mean, we're coming off essentially what is a record year in 2018 is catalyzed really by tax reform and record margins, record earnings.

I wonder how much of this is maybe just a cycle, a business cycle thing versus... A lot of last year people were attributing to the tax cuts job. And actually the Goldman Sachs research is saying the same thing about Q1 and Q2, that most of the beat was because of underestimates of the tax benefit basically so people underestimated the benefit and that really helped q1 how does underestimating the tax benefit explain revenue beats no that's the largest percentage of revenue outperformance we've had in years q2 that subsided a bit it was still well over half but it was not as abnormally high but I think that it's one of the interesting discussions over this lengthy period of margin expansion we've been living through how many are you know Robert brings up the tax issue. I think that obviously added to margins. But I still think people, particularly bears, have to contend with what has been rather stubbornly impressive revenue growth.

Yeah, absolutely. I mean, what would be the bears? Is there an argument to the revenue growth? Well, I think the argument could be that it's going to end. The revenue growth, okay, fine, you've had revenue growth, but now you're not. I mean, I guess that would be the argument. promoted revenue growth because of them being providing an underlying stimulant to economic activity. Yeah, I would. And it's very difficult to disagree with that. I mean, if the cost of money is, is very, very cheap, companies are going to take maybe certain risks that they

wouldn't otherwise, which is going to enable them take maybe certain risks that they wouldn't otherwise, which is going to enable them to have maybe revenue that they wouldn't otherwise if the cost of borrowing was more normalized. So, yeah, I mean, the Fed doing, as far as the monetary policy being so distortive, makes things largely unanalyzable. Like Julian was saying, yeah, the China trade war is a bad thing, but then you have a Fed put and who knows how it all shakes out. So the market, yeah, it's pricing it in,

but it's also pricing in the Fed helping. That's maybe one of the key differences with Europe. I mean, if you think about the growth that the U.S. enjoys and the U.S. always enjoys higher growth is like the Fed or the government is allowed to have a run.

How much is it now? Is it 5% to 10% deficit, GDP deficit every year, right? The budget of the federal government. In Europe, you have a rule that's applied, you know, by the Eurozone members, you cannot be above 3%. So basically, you know, if you go above that, everybody is jumping on you like you're in big trouble. So even Spain and Italy,

when they were a few years above that. It seems more like a guideline over there than a hard rule. I would encourage people to look at Portugal, Italy, Greece, and Spain in 2010, 11, 12, and see if they were limiting their budget deficits to 3%. At the 2010, 11, 12,

and see if they were limiting their budget deficits to 3%. At the time, no. But what I'm saying is like 10 years later, I mean, the U.S. was still growing 3%, was still running big budget deficits. You could think that like one year. I think that on the monetary side, the argument that the central bank accommodation is the excuse for why companies have outperformed expectation, it has a very difficult counter

argument in Europe because certainly the level of quantitative easing and interest rate reduction has been far more aggressive in Europe the last several years than America. And they have been totally unable to create that organic revenue growth on the top line. That's right. That's really the mystery. Why is it impossible to get some growth out of Europe? That's a great point. It's a great counter argument.

What if I don't think it's a mystery? What if I think I have an answer? i'm guessing you're right i guess free market policy no it is because uh zero interest rate are deflationary i guess that's you're going to be your answer but but even then it's not if that were my answer i would beg for another explanation too because explanation too because my answer is that it's part of a negative feedback loop and that the excessive debt to GDP then puts downward pressure on yields which then puts downward pressure on growth which puts more downward pressure on yields etc. So in other words you're right but my answer is a bit more nuanced because I'm arguing for a vicious cycle theory of debt deflation.

I certainly believe the United States is extremely exposed to the same thing, but I think that's more of a forward-looking concern where I think Europe is actually living in it right now and Japan has been living in it for a couple of decades. Really when it comes down to it, the argument that we make as bottom-up people and company bulls on particular cases where we feel very optimistic about a company's outlook, Europe's a great example because there have been standout companies. There have been standout performers. There has been innovation and market expertise that's led to revenue growth

and profit growth and dividend growth that have made for some good performers. And yet that's happened in a milieu of borderline recession and all of the kind of macroeconomic challenges. So, you know, you tell me, Julian, and I'll ask Dan and Robert the same question. As we enter this earnings season, are you more concerned about the top-down macroeconomic climate that we're in in the States? Or are you more concerned about some bottom-up

individual company news that we may end up hearing? Well, you know, my job over the next earnings season, like four times a year, is really going to be to focus on the bottom-up, you know, feedback we get from each of the holdings we have and other companies we attract because at the end of the day, you know, these are the companies we own. And we're going to have a few opportunities to, you know, go through these materials and understand how they're doing.

So you're going to have the press release. Then you have the guidance. And, of course, also you have the chance to listen to management. And when you do a few of these calls, you can hear the tone. It might be different from one call to the next. And the word they use, that gives you a sense of how comfortable, how confident they are about the business and all the questions the analysts are going to ask. So it's really more an opportunity, you know, to take the temperature of the 30-plus companies we own

and then form an opinion based on that, really more on the global economy rather than the other way around. Yeah. Yeah, I think that's a great way to form a good top-down opinion is by doing some bottom-up work and listening to what a lot of this management is saying regarding outlook and growth and so on. As far as top-down versus bottom-up, what we're worried about, was that the question? What we're worried about as far as…

we're worried about? Was that the question? What we're worried about? Yeah, I'm worried or at least more front of center in your mind. What are you thinking about more? What I'm thinking about more is the top down, is business confidence that is affected by U.S.-China trade relations that makes its way into the bottom line or makes its way into cash flows and earnings through rising input costs, through business confidence, companies not investing. I mean, that really starts to affect the behavior of these firms. So that's what I'm concerned

about at the moment. And look, you know, things are never, the coast is never really clear for equities. There's always something on the horizon and potential volatility, and that's why there exists an equity risk premium. But currently, as far as anything foreseeable, that's what I'll be looking at. Robert, why don't you answer the same question, and then I'll transition to a kind of of follow up to this. What are you thinking on all this, Robert? I mean, on the top down level, you know, I'm thinking in the United States, I'm not terribly worried for a lot of reasons. You had the NRF projection, National Retail Federation projection saying that people are looking to spend more this November, December holiday season than historically the average has been, which is good. You know, people are employed, you know, some wage gains, things like that, so they're going to have a little bit more Christmas or holiday shopping. On the bottom-up side of things, I'm not necessarily worried about our own selections

because I think we've done the work to make sure the balance sheets are solid. We have the types of companies we want, but I think a lot of other holders of equities out there might be unpleasantly surprised. You look at the financial side of things, you have net interest margin compression for some of the financials out there. I don't know how many people are ready for that to come through. And then we talked a little bit about the tech space as well. We haven't necessarily seen the full implications of supply chain disruption out there. And I think people are going to be, again, maybe surprised unpleasantly out there. And I think people are going to be, again, maybe surprised, unpleasantly out there. So, yeah. So, so, Dan brought up the idea of where the China trade issues could impact business

confidence, and then therefore, leak into the company results from companies that are reporting. And obviously, that whole theme about the trade war impacting business confidence and therefore business investment has been a macro theme i've been very very plugged into for a long time um in this in the context of extending the economic cycle the idea that capex would serve for as sort of a driver but but since Dan brought it up in the idea about bottom-up impact, I think we could acknowledge that there's some technology companies that are directly impacted because of supply chain considerations with China, certain industrial companies or aircraft manufacturers. Those things are pretty direct. But when you look at consumer staples, let's say, soft drink companies, soap and diapers and household products, brand name type things, is that the reason those companies have gone up so much?

Is it they're disconnected from the trade war, Julian, or are there other factors at play? I would say there's probably a bit of both. They're not totally disconnected because these companies get a lot of their growth from emerging markets. So you have to look at Asia, you have to look at South America. So if the. goes to war with China, maybe, you know, the consumption of Coca-Cola, whatever beverage is not going to be impacted short term. But at some point you could think, you know, if it really goes bad, there might be some, who knows, you know, if people start retaliating with whatever they buy in the supermarket. But I think that's not the biggest

risk, I guess. It's more about really finding where do you find the growth. It's in these regions, but it's probably people on these stocks because they're not cyclical. That's why they're called consumer staples. They have a lower beta, and with the rates being where they are, they look, you know, if you want income and yield, you're going to go for these stocks that still yield, you know, give you better yield than most of the bonds you can buy out there. So in other words, it's not that these companies have performed better because they're removed from the trade war.

But it's also not necessarily they perform better because they're more defensive. It's they're more defensive or they're removed from the trade war because they're more defensive, it's they're more defensive or they're removed from the trade war because they're more defensive. They have a certain financial strength and a certain business model and a certain defensiveness that just sort of goes hand in hand with being more immune from the trade war.

Let me give you an example before you respond. Without going into any particular names, there's this chain of retailers in the United States that's one of the largest companies in world history and is the largest retailer in head count and sales in the entire country. And yet I can't even comprehend what percentage of product on their shelves must have been made in china and yet they're up 26 year to date and and uh so have obviously performed not only well but even better than the market by about a thousand basis points and yet you would think retailers that are particularly exposed to selling low-cost imports from China would have this direct exposure.

I'm wondering, that's sort of making your point, it's not just their exposure to trade war, it's what kind of business they are. Yeah. Yeah. So I think that if you're a retailer and I mean, if you're if you're a distributor in some way, if you serve as a platform, which I think is a retailer that you might be talking about, I think that might be different than if you're manufacturing a lot of your or your supply chain runs through runs through China in many ways. I assume that any sort of company where supply chains run through China has been discounted appropriately by the market. I mean, maybe all those input costs haven't really been realized and come through. But as far as that rhetoric, that increases the likelihood of certain tariffs and input costs rising. increases the likelihood of certain tariffs and input costs rising. So being able to analyze the supply chain and seeing exactly what's going to be impacted, I think takes a great deal of analysis. But obviously different companies are going to be impacted differently. And I'm surprised that there have been some companies where maybe the revenue isn't impacted at all,

There have been some companies where maybe the revenue isn't impacted at all, but maybe their cost structure has a high likelihood of being impacted, and the market hasn't dinged that company as much as it maybe should. I think scale is really important to note, too, for maybe some specific companies, too. I mean, if you're a big enough player, your suppliers in China aren't going to be able to elbow you into raising prices. You're going to say, hey, you're going to take the burden there. So I think that matters for a lot of these big companies, the ones that are kind of the safe harbors as well. And I guess the company you have in mind is very

reliant on the U.S. consumer and as of today, the U.S. consumer is doing fine. The employment numbers are okay. We might be at a tipping point. And if that changed, then they could be starting to suffer. But as of today, the U.S. consumer is doing fine. So all these businesses that are really correlated to the U.S. consumer are performing fine, and the market is giving them the valuation they deserve for that reason.

Yeah, and a lot of this, I think, comes down to the strength of the companies and the strengths of the brands and their ability to pass on higher costs to consumers. Well, look, if you run a commoditized business and your input costs go up, you're going to have to eat those costs. You cannot pass those on to a consumer. So that's where the brand becomes really important. The strength of the company becomes really important. And really how it fits within the industry, that analysis starts to pay dividends. No pun intended. Yeah.

I guess that's why as well, you know, the staples try that 20 times P and then you can buy financials at 10 or 11 times financial. So that sounds maybe more exciting. Yeah, I think that it has to do with where a lot of these sectors started in their valuation, maybe at the beginning of the trade war, let's say, or at some particular point where you want to begin analyzing this. trade war, let's say, or at some particular point where you want to begin analyzing this. I do think that we're right now talking our book as dividend growth folks who obviously have what many consider to be a value bias. I got to say, I think that what you're talking about, Dea, is mostly a risk in sentiment and sentiment, at least initially and sentiment is mostly a risk where

something was already stretched in its valuation so if it's if there's going to be a long lag effect until there's fundamental disconnections in the economy from the trade war which i think in most cases there would be there are certainly some companies that would have an immediate, traceable, quantifiable impact, mostly supply chain oriented technology companies or industrial manufacturers. But I guess the companies, what we've seen is that a lot of the companies started off at such a reasonable valuation, had such a fortress balance sheet, Julie. And that's, to me, the bigger difference is if the whole world's going to go through shaky times, it isn't so much let's not be exposed to the shaky times. It's as Nassim Taleb would say, be anti-fragile.

Be in a position where those shaky times don't disrupt you. Well, how do you avoid shaky times disrupting you? Have less debt. Have less leverage. As Daya brought up about pricing power, I think that these are times. It's a trade war right now, but it could be a real war it could be a recession it could be any number of geopolitical gyrations ultimately there's something to be said isn't there for companies that happen to operate with a more defensive mindset absolutely i could

not agree more and a recession doesn't have to be a bad thing for a business. A recession can end up being a very good thing for a business. I mean, if you have a lot of competitors who have bloated balance sheets and have only been able to expand their business because of the cost of borrowing so low and they're making plays maybe they shouldn't be making and you have been slowly plugging along and building your brand and fortifying your balance sheet and making sure that you're going to be around for the long haul, a recession could really help you.

Maybe some of those competitors would be out of business because they're in a cash crunch, and you could expand your market share, and you'd come out of there a lot stronger. So I think, especially in times like this, it's so important to have high quality companies because it really is the great stabilizer to your portfolio when times are tough. So, yeah. Yeah, I was just going to add that basically the companies we own, they're basically already survivors. They've seen the 2008 crisis, they've seen the internet bubble.

Most of them are companies that have been around for decades and I don't know, you could say like half centuries for some of them or more. And so they're not just new and they have a business model that works and sometimes they change and that's when we have to decide to find a new proxy to be invested in the market. But I guess know, I guess we feel quite uncomfortable with what we own at the moment. And we think, you know, with the relatively low leverage and the valuation that are reasonable compared to the market,

these are good names to own in a tough environment. I think so too. Robert, do you think that there's anything to be said for the fact that we're going to enter this earnings season? There's a lot of questions around whether or not the S&P can maintain this track record of earnings growth with all the macro challenges. There is a fair amount, not overwhelming, but a fair amount of skepticism or skittishness out there. People's expectations are not high. And yet the dividend growth in the names like the ones we own has been high single digits year over year. Does that dividend growth increase that you see in those types of names indicate a certain

contrarian sentiment in your mindset? To an extent. It's somewhat a factor of, again, the companies that we own. They're doing a good job of keeping that dividend growth in line with their own earnings over time. So the consistency factor is really a result of the types of companies. On the other side of it, with regards to earnings, people were predicting an earnings recession or there were talks of this or that with regards to earnings taking a serious dip, Q1, Q2, and then Q3, they're saying they're going to be negative year over year, right? But we didn't see that. And I think they're lower than they were last year for a number of reasons. And my prediction is this is kind of maybe a bottoming of the earnings growth, you know, the bottoming of the second derivative of earnings growth. I would say it's probably going

to continue accelerating through the end of the year and into next year as well. And, you know, the dividend growth year over year should probably follow that. But I wouldn't predict it to go, you know, double digits or anything like that. I think it would be high single digits more than last year to this year, but I think continued growth. Julian, what do you think? Do you think that dividend growth in this quarter is going to slow versus what we've seen the last couple quarters? Or is your feeling that as free cash flow goes, so goes the dividend?

I guess we've already seen most of the dividend increases for this year. You know, most companies like run a fiscal year calendar. So they have announced, like if you look at the companies we own, I think 95% of them have already announced their dividend growth. But I think the way they think about dividend growth is not over one calendar year. It's more over like three, four, five years. That's when they, you know, they have their business plan and they present like an investor day to investors.

So, you know, regardless of what happens in the short term, they, you know, if they have to have a target of, you know, high single digit dividend growth, they're going to stick to that for the next few years, regardless of the, you know, small change in the economy in the short term. So you will really need something massive to happen like a 2008 recession for them to reconsider it. And the one we own, they usually have 30, 40, 50% payout ratio maximum. So they can afford to go to one year. If they have bad earnings one year, they can afford to go to 70% payout ratio. And then the next year they'll be back to 30%.

I think the short term volatility is not going to really impact the dividend growth. So volatility is not going to impact dividend growth. Volatility this quarter, perhaps making some companies more attractive. I'll go around the circle. I'll start you, Julian, then go to Dea, then Robert. Let's say earnings contract year over year, low, low, low, single digits. So there's some contraction in year over year growth, but dividends, excuse me, earnings are down one to 3% versus this time a year ago. Does the market drop? And if so,

does it drop meaningfully? So you said, so earnings drop and dividend growth stays constant? Sorry. Yeah. But right now we're not going to the dividends, although I certainly would say I certainly am not anticipating that there's any change in dividend growth from earnings dropping 1% to 3% and in our portfolio at all. But my question, just to simplify, is around S&P earnings. If they drop 1% to 3% year over year, do you anticipate a market drop? And if so, does it make the market more attractive?

Julian? Well, I think it doesn't matter so much what happens on this year earnings. I'm worried about, okay, do we have to reassess next year earnings? Because at the moment, the market is still, I think, assuming around a 10% growth and I might be a bit optimistic. So, you know, if it goes down to high single digits, five, six, seven percent,

that would not necessarily mean that the market needs to go down, but that means that there's not so much upside, maybe, for next year. But, you know, all this, I'm not sure, justifies the market needs to go down, but that means that there's not so much upside maybe for next year. But all this I'm not sure justifies the market going much lower given where the rates are. Dan?

I believe it's consensus that the earnings are going to drop by that range, that 1% to 3% range year over year. Is that not correct, David? Well, that's the consensus, but the consensus has been wrong two quarters in a row. Okay, okay, okay. Right, it's been wrong two quarters in a row, and I

think the market has adjusted. I guess my point is I think if the earnings end up doing what consensus estimates they're going to do, I doubt the market is going to have a huge reaction one way or the other. And if it does, that will probably present an opportunity. So yeah, that's where I'm at with that. Yeah, I would tend to agree. I think it's largely priced in. There might be a little bit of a drop through the quarter for this and that, but I'd be more interested in digging into which parts of the market had a negative attribution, right? So is it going to be a tech?

Is it financials? And then, you know, what we care about most is the bottom upside. There's probably going to be some nice surprises, I would imagine, from, you know, our holdings, things like that. And I'm excited for that, frankly. Yeah.

Some bargains. Yeah. Yeah. Well, I think those are good answers. And I think that it's good collective wisdom to be thinking about the potential opportunity that may come. One of the things I guess I would encourage listeners to be thinking about is the possibility that earnings disappoint,

they come in line with consensus, which is at a little bit of a drop. Again, I'm speaking across the whole market here, so kind of in a macro sense of S&P companies. You get just kind of so-so quarter, but then the markets don't drop meaningfully. So you get this sort of no man's land where you're not getting great buying opportunities, not a meaningful sell-off like we got in the fourth quarter of last year, but then you're also not feeling great about the earnings growth. And then that's where I think, Julian, you really nailed it. There is very little consensus to be found, let alone what I would consider intelligent projection around what 2020 earnings are really going to be.

And I can't recall a time since the financial crisis where there was this much ambiguity as to what to expect a year out in earnings. There is a plausible case to be made for 10% earnings growth. And there's a plausible case to be made with the right kind of trade war escalation and business slowdown and global contractionary impact that you could be looking at a 10% earnings reduction. Remember, earnings are up so much since Trump was elected. You could have earnings drop 10% year over year and still be way higher than we were drop 10% year over year and still be way higher than we were at this time in 2016. So I don't know that I want to suggest there's a 20% margin of error around earnings. Like they could be plus 10, minus 10.

But I wouldn't suggest that there isn't. I guess that's really the problem. It feels like going into 2020. Last year, I guess we got what happened in Q4 because the Fed did a bit too much tightening. This year, they are accommodative. So the big question mark now is trade war. And I guess we could have a nice surprise.

And then if it's started this month or next month then you could see really a 10% earnings growth next year but and maybe we should you know be optimistic because nobody is pricing that so there has always has to be a chance of what you don't expect always happens but it's hard to see this happening at the moment. So with this uncertainty around 2020 earnings, do you think there'll be more volatility? What do you guys think? Volatility is here to stay, and you also have election year. The only thing that we have with us at the moment also is the Fed.

It's been easing. If you look at the projections now, expectation is like 80% of a third cut in October. And that's after Jay Powell was talking today. So he wasn't really pushing back on trying to delay the next cut to December. So now it's pretty much there, and it will be hard for the Fed not to do a cut in October. Yeah, I think that it's good to recognize that there's going to be multiple inputs to

how a lot of this will play out. Here's what I'd say. If you are going to have a 5% to 10% earnings deceleration next year and you're starting off at a 17.5 multiple, it's almost impossible to see how you can get to a positive total return. Because you're going to have to have a multiple that from 17.5 in a declining earnings market is going to grow high single digits, which would put you at about 19 times. To Julian's point, the Fed would like to do everything they can to help that. end's point, the Fed would like to do everything they can to help that. And yet I have a hard time believing that that anticipation is not priced into this market multiple now. In other words, the Fed could hurt the market by not accommodating, but I'm not sure how much more they could help

the market with further rate cuts at the level that they're already at. I could throw a wild card out there today. Jay Powell was talking about more balance sheet activity and saying it was not the same as quantitative easing and he's providing a technically academically correct answer. But what if they got rid of that and just said, "'Nope, we actually are doing QE4." I would anticipate that that would be a pretty good way to get the market multiple even higher. Now, again, these are not things I'm forecasting. These

are not things I think that we as an investment committee are expecting or making asset allocation decisions around, but I'm trying to think as to why sometimes getting certain premises right is not enough because the way that the premises move to a conclusion can be very, very unexpected. Robert, what do you think about all this? Well, the QE but not QE comments are still kind of having me think a little bit today, but I think you're absolutely right about all of it. And I think the comments from Day and Julian are near unimprovable. I mean, it's all about the individual companies that we're looking at going forward. And you said something extremely wise as usual,

you know, when you're starting at a certain, uh, PE, where are you going to go from there? If, uh, everything doesn't go right. If the plan doesn't come to transpire. Yeah. Yeah. I, I, I, I couldn't agree more, uh, focus on the individual companies as far as the way, I mean, it sounds like the way you put it that way, yeah, there's already a lot of monetary policy that's dovish that's been priced in. How is it possible that earnings could decline and then multiples expand? I think that would be very difficult. I think QE4, that probably would make it happen. QE4, that probably would make it happen. Maybe

if the trade war had escalated and then we get towards the end of the year and then it's clear sailing somehow, there's an agreement totally ironed out, I think that's also a way that the stock market multiple could expand. There's not a lot

of ways to see that multiple expanding. So let me kind of get us to a point of ways to see, to see that multiple expanding. So, so, so let me kind of get us to a point of wrapping this up and I'll let each one, each of you make some closing comments and feel free in your closing comments, guys,

to go anywhere you want, recap some of the stuff we've already talked about or offer up a new consideration. But here's where I would kind of leave things. What we've talked about today without a whole lot of direct, intentional, purposeful context is an incredible argument for being bottom-up, selective, and yes, dividend growth-minded. Because you right now have very compelling arguments that are not based in certainty. They're just based in reasonable probabilities of challenges to market valuations.

You have trade war uncertainty. You have the potential for, if you're an index investor or maybe a mutual fund investor who owns hundreds of companies, you have a reliance on multiple expansion because even if the earnings growth is a little bit better than expected, no one believes you're going to get 10% earnings growth easily. 10% earnings growth easily. And yet to go up 10% for a year in the market without 10% earnings growth means you're relying on more multiple expansion, you're relying on the PE going higher. And I think that most people would say that starting off at 17 and a half times, and by the way, when I say 17 and a half times, this is way when i say 17 and a half times this is very important that is not because we've been going higher and higher and higher the market right now october of 2019 is at the same place that it was in january of 2018 now the earnings are much higher and so the multiple sort of calibrated around that but my point being

that it isn't like well we've gotten this great multiple expansion and as the market's risen we're just at kind of an expensive level and i think that that focus robert talked about it individual companies um the sensibilities around where dividend growth is, something Julian is very focused on in unpacking these earnings results. I don't know. I can't imagine a better, more sensible, risk-adjusted way to approach equity markets right now than in the context of dividend growth. So I am getting the worst closing comment out of the way first. So I'm now done, but I'm

going to let, we'll just go in the same circle, Julian, then Dan, then Robert, you'll close this out. Well, I guess at the end of the day for me, it's, I've been, you know, a stock picker for like 15, 20 years. And it's always about owning companies you feel comfortable owning at night because you think they will survive because you think they don't have too much

leverage because you understand what they do because they have a clear strategy, they have barrier to entries, they don't have crazy valuation and

I think that's really what we own. We have a portfolio that has a weighted average P multiple of 13, and that's paying 4% dividend. And that's compared to the S&P at 17 and the 2% dividend yield.

So I feel quite comfortable with that going into this environment. And I agree. I mean, it's easy to, what you said about the multiple expansion is really key. I mean, people forget that they make a lot of money from earnings growing every year for the last probably, what, nine years now since 2009 and also getting multiple going from 10 to 17. So you had the double whammy

and now from 17 is hard to get much higher. The only way you can get much higher is from TINA. It's from the fact that the Fed is telling you put your money in equities because we're not paying you anything for having bonds. But it's not going to go to 30 times unless you have like some crazy 2001 internet bubble, in which case you really don't want to be in an index.

Yeah, yeah, very much so. I think that, yeah, and for the past 10 years, yeah, the stock market's gone up, I think, around 250% since 2009, January of 2009. And earnings have been up a couple hundred percent. And 17 times, I mean, look, if you have a strategy that's predicated on multiple expansion, I mean, good luck to you. That's a pretty hard thing to predict given it's depending a lot on the mood of the moment. So we stay away from strategies that are dependent on multiples and it makes things analyzable and makes things simple. So Robert and David and

everybody here has touched on it. We look for bottom-up names. We're looking for bargains. We're looking for companies that have pricing power. And we're looking to collect about 30 of these names and sit on them for a very long time. So, yeah, so at the end of the day, we do things in a simple way that takes away a lot of this guesswork around psychology and what the market might be feeling or not feeling or your outlook. So, yeah, bottom up and keep focused on the long term. Yeah. Earnings season is the best.

Yeah, I mean, especially in times when there's maybe challenging macro factors or external factors coming in, when you look at the data, which is what earnings represents, you're able to really separate the wheat from the chaff in terms of the companies that you want to own, you do own, or you shouldn't own. So I'd encourage people to get interested in earnings. I know that we certainly are over here. I think Julie and the team are going to be plugging into that. But very exciting times for us going forward, and I'm frankly excited about our companies. Great stuff, guys. Thanks for listening to this week's Dividend Cafe. Our investment committee will rejoin you, of course, next week.

And in the weeks ahead, one of the exciting things we have coming up is our annual due diligence trip. Both Dea Pernas and Brian Seitel will be joining me in our annual due diligence trip both Daya Pranas and Brian Seitel will be joining me in our annual trip lots of meetings with our money managers and portfolio relationships hedge funds and things that nature in a couple weeks ahead so count on hearing more recap around a lot of that discussion the follow-up in earnings season. We're all staying quite busy with this, but great discussion, guys, and I'll see you back in California, okay? Thank you for listening to The Dividend Cafe, financial food for thought. offer through Hightower Advisors LLC. This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process or the investment

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