Two profits warnings, two different triggers but one painful outcome – Burberry and Walmart saw their shares fall by more than 10 per cent in a single day recently. Actually, both companies have something else in common – far from presenting investors with a shocking new piece of information, both were merely confirming what they had already told shareholders. The surprising thing about each of these warnings was that so many were surprised.

In the case of Walmart, the warning – which knocked around US$20 billion off the retailer’s market capitalisation – simply added detail to August’s earnings guidance. Two months ago, the company flagged a higher wage bill and the high cost of competing online with the likes of Amazon Prime. The most recent alert, which wiped a tenth off the share price, merely quantified the squeeze on these two fronts – up to 12 per cent off earnings in 2017.

As for Burberry, the impact of China’s slowdown on a business which sells up to 40 per cent of its luxury coats and scarves to Chinese buyers can hardly have come as a shock. Back in July, Burberry warned that Hong Kong, responsible for a tenth of company sales, had been hit by declining numbers of mainland Chinese visitors thanks to local hostility and the relative attraction of regional destinations like Japan, where Burberry has a smaller footprint.

The value of effective interpretation

What is interesting about these profit warnings is the fact that the information they provided should have been in the price already. The glacial incorporation of new developments into investors’ understanding is a slap for the efficient market hypothesis. In a world of instant and widespread information, the value of effective interpretation – much harder to do and slower to achieve – is undiminished.

This is particularly the case when the information disagrees with our view of the world. Investors are reluctant to accept ideas that do not confirm their biases. In the case of Burberry, the Chinese slowdown is hard to digest if your whole investment strategy over the past 10 years or so has been based on the unstoppable rise of a vast urbanised middle class in the emerging world.

The disruptive idea hinted at by Walmart’s profit warning is even more unsettling. What if the multi-decade shift in economic power from labour to capital has run its course just at the moment when thinkers like French economist Thomas Piketty are bringing the idea into the intellectual mainstream. The introduction of the living wage in Britain, China’s increasingly uncompetitive labour force and now perhaps early signs of a reversal of the US’ growing inequality have big implications for investors.

Investors need to grapple with many of these revolutionary thoughts at once if they are to stand any hope at all of predicting the next profit warnings and so protect their portfolios. For example, a publishing friend of mine forecast to me that his industry will soon follow the music business into the Spotify model. Why would anyone buy a book when they can buy a subscription that gives them access to a global library?

Why, for that matter, would anyone buy a fridge? If you have ever wondered why your current fridge is so much shoddier than your previous one, the answer is in the ownership model. It is not in the manufacturer’s interests to make a better fridge that lasts even longer. But if you leased the fridge from Bosch it would absolutely make sense for them to make a great machine with a higher resale value at the end of the contract.

Profit warnings on the rise

Economic disruption is one reason why I expect there to be more profit warnings in future. Another reason is cyclical. We are at that stage in the cycle when companies can no longer patch up earnings growth with cost-cutting, share-buybacks and other smoke and mirrors measures. Eventually companies need to rebase expectations. This is what happens when a new chief executive takes over, but sometimes you don’t need to wait for a new boss to do it.

So if profit warnings are inevitable and likely to become more frequent, how should you handle them? First, have a plan – don’t react in the heat of the moment, because you will make a poor decision. Try to judge whether the warning is a one-off or a symptom of something harder to fix. Think laterally about who else might be affected by the same problem (or benefit from it). And make sure that your portfolio is sufficiently diverse that the next Walmart or Burberry doesn’t finish you off.

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