Chief Investment Officer Bryan Hinmon discusses second quarter earnings.

The investment team at Motley Fool Asset Management followed nearly 200 companies during the most recent earnings season. In this video interview, I spoke about about:

  • Companies whose performances stood out
  • The affect of trade and tariffs on various earnings reports
  • The general state of the economy and stock market
  • Stories to watch throughout the rest of 2018
  • And more...

You can watch the video by clicking the play button in the video player below. And you can read the interview transcript by scrolling below the video.

(Note: This video was filmed on 8/13/18 and covers the earnings season that took place in July and August. During the course of this video we discuss particular companies, securities, and investment strategies. Do not take this as personalized investment advice. We are not trying to recommend that you buy, sell, or hold any of the companies that we discuss today, nor are we advocating an investment strategy for any of you as individuals. The views expressed in this video are those of the speakers, and are subject to change. Please click here for holdings of the Global Opportunities Fund, Small-Mid Cap Growth Fund, and Emerging Markets Fund.)

 

MATT TROGDON: 

Hello. My name is Matt Trogdon. I'm the director of communications and marketing at Motley Fool Asset Management, and I have with me today Bryan Hinmon, our chief investment officer. Bryan, how are you?

BRYAN HINMON: 

Doing great, Matt. Thanks for having me.

MATT TROGDON: 

Great. Thank you for joining us. Bryan, I just wanted to chat with you about a couple of things now that we're on the tail end of earnings season, hopefully to give our readers and shareholders a better sense of what has been going on in the markets and where we think the markets are going. 

Let's just jump right in. You and your team cover almost 200 companies, so that's a lot of earnings to go through. What are a couple of companies that surprised you on the upside, and what are a couple of companies that surprised you on the downside?

BRYAN HINMON:

Yeah, about 92%, 95%, of companies in the S&P 500 have reported now, so me and my team are finally coming up for a little bit of air after going through these countless earnings calls. We've had some winners and some losers.

I'll hit on a winner in our portfolios first. This is a company called Paycom Software. Paycom is a company that we own in the Global Opportunities Fund, and we also own in the Small-Mid Cap Growth Fund. This company makes payroll and human capital management software for small businesses, and they deliver it via the cloud. This is a SaaS software company. Now, this company has been on a tear as it is, but the stock was up 20% because sales growth actually accelerated to 31%. What we've seen here is simply great execution.

With a very healthy US economy and small business environment, more companies are choosing to use a software solution for payroll and really to manage the entire life cycle of an employee from hiring to talent management throughout their career to retirement. This is a great little business that we are happy to own a bit of.

MATT TROGDON: 

Great. How about on the downside?

BRYAN HINMON:

Yeah, we have some of those too. The one that really sticks out to me is a company called IPG Photonics. This is a company that we have followed for a really long time and owned for quite a while. It's a top 10 position in the Global Opportunities Fund. We also own it in the Small-Mid Cap Growth Fund. This is a high conviction holding for us. 

IPG makes fiber lasers that are used in all sorts of manufacturing techniques and industries. The company was down about 25% on the quarter, not actually because it had a lousy quarter. It grew both revenue and earnings during the quarter and year-to-date, and in very healthy fashion, but management guided for a little bit more caution in the back half of the year, citing trade and tariffs having an impact on customer orders.

The reason we're seeing that in such a pronounced way at IPG is because they sell ... 45% of their total sales are in China and another 20% are to Europe. This is a company that, although it's headquartered in Massachusetts, does a preponderance of its business in China and Europe with manufacturers there. Management saying that customers are pausing orders and the back half of the year is going to be weaker, and the market punished the stock.

MATT TROGDON: 

Bryan, that brings me to another topic I wanted to talk about. You mentioned trade. You mentioned tariffs. Is that something that you all heard about on a number of calls? If so, what were people saying?

BRYAN HINMON:

We definitely heard about it on a lot of calls. It was a key topic of interest for analysts who get the opportunity to speak to management every quarter. But really what I saw in the calls that I read and in the management teams that I was able to speak to was very uneven, uneven application of the impact of tariffs. It's easy to see in the case of sales. We just spoke about IPG Photonics, right? The management team there is seeing orders slow down, so future sales are expected to be lower.

Another company that we own in the Small-Mid Cap Growth Fund is called LCI Industries. They make component parts for RVs, for manufactured housing and boats. What that means is they buy a lot of steel and a lot of aluminum. Their sales, which are to US consumers, are still incredibly healthy across those markets, but what they're seeing is they're seeing cost pressures. In the last quarter, aluminum prices were up 25%. Steel prices were up 30%. Their profitability is being pressured, for sure. Now, a healthy US economy is helping absorb some of those cost pressures, so they're able to pass some of those along to their end consumers, but not in real-time. What you see is a healthy sales environment, but a pressured profitability environment.

Those are two instances where there are obvious impacts from the trade and tariff issues that are going on right now, but when it comes to sort of a bigger picture, the company's call that I like to focus on is called Fastenal. Fastenal is a distributor to thousands of industrial companies across the US, so they have a very comprehensive view of how the industrial economy is behaving and how customers are feeling. Fastenal had a great call. Management commentary there showed that their customers are aware and wary, but they're not seeing, for instance, customers stockpiling inventory ahead of those rising prices, or they're not seeing sales cut back dramatically because their end consumers are not buying. We're seeing a little bit of mixed results here from the trade and tariff impact. There's not just one thing that I can point to. It's been a very uneven application.

MATT TROGDON: 

Bryan, if we look at our overall impressions of earnings this past earnings season as they relate to the economy and the general market, what do we see? I know we're late in the cycle, or at least that's what a lot of people are saying. What did you see?

BRYAN HINMON:

Matt, earnings were strong in the second quarter. With about 95% of companies in the S&P 500 having reported so far, a pretty incredible 70%-plus of them reported positive sales growth surprises. It's important to call out that that's sales growth and not profit growth, so we're not talking one-time impacts from tax changes or anything like that. That is more people, more consumers, more companies buying products and services from these businesses, just incredibly strong sales growth. It was almost 10% on average for the quarter. Some of that is a recovery in energy companies, which last year had very low sales, so there's some recovery step-up in those sales.

But by and large, sales growth was strong across the board, and that is a great indicator of the health of the overall economy. Not only that, but it was incredibly broad-based. 10 of the 14 sectors that the S&P classifies showed positive sales growth, so you're talking broad-based strength, very strong growth, and then what I like to look at to sort of get an indicator for the future is, what are industrial companies saying? Because that's among the most cyclical of the industries. S&P 500 Industrials are expecting 12% profit growth for 2019. We see generally strong earnings growth driven by strong sales growth, which paints the picture of a pretty healthy economy.

MATT TROGDON: 

Bryan, what are some of the stories you and your team will be watching in Q3 and as we move towards the end of the year?

BRYAN HINMON:

Matt, I think there are really two things that I'm going to be focused on. The first is China/trade. You can't avoid the headlines. What we've tried to do is figure out the signal from the noise. Right now, there's a lot of noise, and you're seeing that reflected in the price of Chinese stocks. The Shanghai Composite is down about 15% year-to-date. Call it what you want. Is it a trade spat, a trade kerfuffle? What we're watching for is whether or not it develops into a full-bore trade war. Right now, we are not there.

I think it's important to realize that China's economy has evolved over the past couple of decades, such that the growth in China is driven by consumer spending now. About 75% of the growth is driven by consumers and the rising middle class there. The import-export story is still important to China, for sure, but it's far less important than if we had been having this conversation five years ago. With the Chinese market down 15%, you would expect what would be driving that is Chinese industrial manufacturing companies, but really it's broad-based. I mean, you look at some of the Chinese internet giants that are wonderful businesses, like Ctrip, Tencent, and JD. All of them are down 15 to 20%.

Now, these are businesses that over the last couple of quarters have, in our opinion, been building business value. They have been executing their strategies of acquiring users and starting to show some signs of monetization of them just in a really fantastic way, as well as launching new products and making investments to ensure that they'll be growing for the long term. When we see that disconnect there, where the Chinese industrial economy you would think would be driving the indexes down because of the trade rhetoric, but the technology companies and the more consumer-focused companies are also being drug down with that, that is a type of situation where we're saying, "Okay, there could be opportunity there if the noise gets louder, so we're digging in."

The second story that I think we'll be hearing more about and will be paying attention to is the inverted yield curve in the United States. Very quickly, what this means is we hear stories of interest rates rising, and that is happening in the US. There's no doubt about it. The short end of the curve, so to borrow money for six months or a year, those rates are rising faster than long-term rates, which are basically doing nothing. When you get into the situation where short rates are equivalent to or higher than long-term rates, that is a sort of signal that there could be a recession. We're hearing more and more recession chatter out there among economists, but that really doesn't jive with the data for us. The louder that that noise gets, we think there will be more opportunities to buy high-quality companies at great prices.

MATT TROGDON: 

Here with Bryan Hinmon, chief investment officer of Motley Fool Asset Management. Bryan, I know you and your team pride yourselves on being bottom-up investors. Obviously, the macro economy is something you have to pay attention to. However, how do you marry those two things as you're doing your stock research and as you're picking a company?

BRYAN HINMON:

Yeah. Well, I think that looking at the broad measures of the economy is really a pretty crude measure, because it can be distorted by outliers. It can be distorted by poor measurement techniques. It's dangerous just to rely on those big picture items or those broad-based calculations to inform ... to overly exert impact on your investing decisions. But we don't want to ignore what could be very valuable information that's relayed there. What we do is you said the word. We try to marry that top-down data with what the bottom-up company fundamentals are telling us. My team of six, we cover about 150 companies very closely, and we all have watch lists of great businesses that we'd love to own one day but that haven't presented that opportunity for us yet.

When you roll that all up, we are monitoring about 200 companies on a quarterly basis, and trying to fit together the different puzzle pieces and marry that with what the top-down is saying. Being a bottom-up fundamental investor, we think that it's a heck of a lot easier to understand the drivers of change at that company level than at the top-down level and how that's going to impact the long-term trajectory of the business. When it comes to trying to predict the future and make forecasts, we don't try to do that at all from the top-down. We only try to do that from the bottom-up, and we use the top-down information to point us to where our research might be best directed, where opportunities might exist.

MATT TROGDON: 

Excellent. Thank you very much, Bryan.

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