Why is the market so happy with profit reporting season? A SmartCompany Q&A.

It was supposed to be the worst profit reporting season in almost two decades, when a year of falling sales, job cuts and asset writedowns caused a flood of red ink on the financial reports of big Australian companies.

Yet investors appear to have been pleasantly surprised by the results delivered thus far from companies including Brambles, insurance giant QBE, the resilient JB Hi-Fi and Retail Food Group.

So why has the market responded so positively to profit reporting season? And what does it say about the state of the economy?

Time for a SmartCompany Q&A.

The sharemarket seems to be going along quite nicely at the moment, and yet I’ve been noticing some companies have posted some pretty big losses. What’s going on?

You’re right on both counts. The Australian market is up around 7.25% since mid-July, when profit reporting season officially kicked off.

You’re also right that there have been plenty of losses. In fact, according to figures from Shane Oliver, chief economist at AMP Capital Investors, profits are down around 18% in total, with about 60% of companies having reported.

Profits down 18% and investors are happy?

It’s all relative. Most analysts had expected profits would be down by around 23%, so 18% looks pretty good.

Things are not as bad as they seemed then.

Exactly. Oliver says that with 40% of companies still to report, 46% of profit reports so far have been better than expected, with just 11% coming in worse than analysts anticipated. Not bad for recession-like conditions.

Oliver also says that 55% of companies have seen their share price rise by more than the market on the day their result was released, which gives you a good idea of how bullish investors are feeling right now.

Which companies have pleasantly surprised punters?

Oliver nominates Newcrest, James Hardie, OneSteel, United Group, Qantas (despite a big loss), Woodside, Brambles, Downer EDI and QBE.

To that list we’d add a number of small companies including iiNet, Retail Food Group, Country Road, iSoft, Domino’s Pizza and The Reject Shop.

What are they doing right?

The companies that have got through this period well have been able to keep costs tightly controlled (although most of the smaller companies have resisted the temptation to cut too many jobs), focus on the “value” element of the product offering (keeping prices relatively low to ensure the cash registers keep ringing) and, particularly at the smaller end, they have continued to invest in expanding their businesses with new stores, new products and new markets.

Any companies particularly on the nose?

Conglomerate Wesfarmers, which owns Coles and Bunnings among a swag of other businesses, got a lukewarm reception despite delivering a 44% rise in net profit to $1.5 billion.

What investors are particularly looking for in these profit results is the statements about the company’s outlook. While many of the better-performed companies have been positive about their outlook for the next 12 months as the economy recovers, Wesfarmers was a bit more cautious – and investors didn’t like having their mood spoiled. Wesfarmers was sold off and is down around 5% since its results announcement on 20 August.

So what do the profit reports so far tell us about the underlying economy?

That the recovery is really happening. While companies have been cautious, it’s clear that most are seeing a good level of optimism amongst their customers. However, this morning’s result from Fairfax Media – which delivered a 27% fall in underlying earnings and a $380 million loss – suggests that businesses are still under a certain level of pressure. Fairfax said that while the decline in advertising appears to have bottomed, a “material recovery” in advertising has not commenced.

Any big profit results to watch out for?

There are some really big ones this week, including Flight Centre, Foster’s, Harvey Norman, Woolworths and Virgin Blue. These will give us an even better idea of how some of the big sectors are tracking.