Insight

Last year’s profit-reporting season wiped about 6.5% off the value of the Australian sharemarket as investors reacted to a string of negative surprises. Many companies reported profits that were worse than expected, prompting a steep market fall that was even sharper than the sell-off during the 2009 reporting season (which saw about a 4.3% fall).

Investors punished companies because a lot of results contained negative surprises and earnings that disappointed expectations. When many firms report weaker profits or downgrade guidance at once, confidence falls and share prices are often marked down quickly by the market.

Analysts have highlighted profit downgrades in sectors that are closely tied to the economic cycle, including metals and mining, construction and engineering, media, retailing and gambling stocks. These areas have seen more warnings that profits could be lower.

Reporting season matters because super funds and many everyday investors are heavily exposed to the sharemarket. Large falls in share values caused by disappointing results or widespread downgrades can reduce investment returns and hurt retirement balances if losses are significant.

Profit downgrades occur when companies tell the market their expected earnings will be lower than previously forecast. They matter because downgrades often trigger falls in share prices, change analyst expectations and can signal broader weakness in particular industries or the economy.

Credit Suisse analysts found that, since the half-year reporting season in February and March, very few local companies have been saying profits could be better than expected. Instead, many have been warning that profits could be lower, contributing to a cautious market mood.

The crisis that began in 2007 has morphed from a banking problem into sovereign debt and political difficulties in parts of the world, slowing global growth. Worsening conditions in major economies and uncertainty about policy responses in the US, Europe and Asia can reduce demand and put pressure on Australian company profits.

Keep an eye on company profit guidance and any profit downgrades, especially in cyclical sectors like mining, construction, retail and media. Also watch commentary on leading economic indicators and policymakers’ responses overseas, since global growth and policy uncertainty can influence Australian corporate earnings and market reactions.