Get Positive by Going Negative

 | Jan 09, 2013 | 6:00 PM EST
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As soon as I hit the send button on Tuesday's column, I knew my phone would be ringing. Sure enough, the phone rang off the hook last night with friends and associates wanting to discuss my views on earnings season (and the 2013 American League East). Most traders, and a majority of investors, focus on the quarterly earnings season as the be-all and end-all of markets. I politely disagree; it is just a check of vital signs in a long process. The inevitable question was eventually asked: If you were a trader, how would you approach the earnings season with an eye on turning a profit?

It is a fair question. I am not a trader, but I do spend a lot of time thinking about markets, talking about markets and researching stocks and markets. I hang out with many traders and other disreputable types and I have occasionally put on a trade or two. I could never do it full-time, as the time spent hanging on every tick cuts too far into my reading and baseball time, but I do know the game.

The first thing I would do is not do what everyone else is doing. Traders will be watching the same set of stocks as they do every quarter. What is Apple (AAPL) going to report? How is the whisper number at (CRM) trending? They will watch the big bank as if the amount of trading revenues and reserve releases contain some clue about the universe and the stock market. (They don't.) Almost everyone I talk to is trading the same stocks using the same estimates and charts. It is not a recipe for success.

I would approach this differently. I would look for companies that have experienced a string of negative earnings surprises. When a company has several negative reports in a row, analysts scramble to lower their numbers aggressively. It is OK if one of the stocks has a positive surprise, but a negative one that costs institutional clients their money is a big no-no if you want to keep your comfortable office and big bonus structure. Almost everyone has a loss in the stock and sentiment is overwhelmingly negative. No one will be talking about the stock and it will be off most traders' screens.

Look at a chart of Farmer Brothers (FARM). The coffee distributor reported four straight huge earnings misses in the last part of 2011 and into 2012. The stock fell like a rock as estimates were lowered by Wall Street. In the third quarter, the company posted a positive surprise and rose by almost 40% by the end of the year. Everyone hated the stock, and when it surprised to the upside, traders and investors scrambled to get into it.

Using data from Zacks, it is not difficult to put together a list of stocks that might have a positive surprise that lifts them over the next several months, or even weeks, for the short-term traders among us. First Midwest Bancorp (FMBI) has posted five consecutive negative earnings surprises. Estimates have been dropping. The stock price improved earlier this year as the bank announced aggressive steps to deal with nonperforming assets. A positive earnings surprise could give the stock an addition short-term boost.

It didn't take Molycorp (MCP) long to go from loved to loathe on Wall Street. The company mines rare earth minerals that go into everything from smart phones to water treatments. The stock ran up above $70 after its 2010 debut, touted as one of the few rare-earth miners outside China. The company has posted five consecutive earnings misses and the consensus estimates have plunged along with the stock price. No one expects much out of the stock and, more importantly, no one cares. Twenty-eight million of the 91 million shares in the float are short, so if MCP exceeds the estimate of a $0.11 loss when it reports on Feb. 13, this stock could bounce sharply.

There are other interesting names on the list. Cross Country Healthcare (CCRN), a staffing company, has posted four consecutive negative earnings surprises. Oil and gas exploration concern Bill Barrett Corp. (BBG) has missed four of the past five quarters, and three in a row. Loss-prevention specialist Check Point Software (CHKP) has missed four in a row. There are plenty of these stocks to choose from, and I believe they make a better universe for earnings-season traders than all the larger, better-covered and better-loved stocks that most traders insist on trading.

If you insist on doing what everyone else is doing on Wall Street, you will be part of the chatter on bulletin boards and around the water cooler. I am not sure it will make you very much money, though. Think differently, and find situations that allow you to gain an edge with little or no competition for trades.



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