Performance anxiety ahead of reporting season

The high expectations for earnings growth this financial year may be questionable, but there are opportunities for small caps.

Analysts are expecting stocks on the Uncapped 100 to deliver double-digit earnings growth when they turn in their report cards next month and the growth trend is expected to continue into the current financial year.

This has prompted some to question if expectations are set too high given the challenging economic environment that we are still struggling to get through.

There’s good news and bad news on this front.

The good news is that the 2012-13 and 2013-14 median earnings before interest, tax, depreciation and amortisation (EBITDA) forecast for the Uncapped 100 of 15.9% and 15.3%, respectively, is on the whole believable.

The optimistic predictions are not generally a product of over enthusiastic analysts getting ahead of an economic rebound, but because a good number of Uncapped 100 stocks are facing (or have faced) a significant step change in earnings.

The strong improvement in earnings is also helped by predictions that a number of companies will post much smaller operating losses in the last financial year. These include the likes of laser technology company Silex Systems (SLX) and biotech Starpharma (SPL).

Others are also expected to receive material milestone payments, such as biotech Acrux (ACR) or enjoy a ramp up in production, such as Sundance Energy Australia (SEA).

While the anticipated upswing in earnings for a number of these stocks are not so much related to economic activity, the bad news is that there is still a risk that they can still miss profit expectations if they do not meet the required milestones or production targets.

There are also a few stocks with over enthusiastic expectations built into their share price (see Big expectations for small caps).

One way to weed these out is to see if the increase in profit is based on a notable uplift in profit margins, given the cost pressures facing many industries over the past year.