Weekend Watcher: Basic Survival Skills for a Frazzling Market

 | Jun 16, 2012 | 6:15 PM EDT  | Comments
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"How could this guy possibly be lending advice on anything other than the Greek election?" you may ask as you read further. That would be totally fair commentary -- but, hey, I have already examined the subject and am mentally prepared, besides. More important, there will come a moment when the principles learned in Investing 101 will supersede the Greek news of the day, and that's where you'll find it vital to be prepared with solid strategies. In my opinion, loads of lessons should have been gleaned in the past two months -- and you should keep track of these for future reference as you continue monitoring your positions.

Today, I want to demonstrate how the market will read most good corporate earnings news when it's dealing with a bout of psychosis. I believe the guide below works best in periods of moderate to rising stress on the markets. During these periods, the market is looking for excuses to sell, regardless of any positives the investor is able to spot in a company's 8-K form with the SEC. Keep in mind that, when you observe a stock pulling back on broad-market travails after the company issues a respectable earnings report, this is a company you should revisit as volatility subsides -- and it will subside after a while.

Let's be real: The basic rules of investing have been tossed in the trash bin. Blame the Lehman Brothers crisis. Blame the Federal Reserve's quantitative-easing injections, which have distorted the functioning of free markets. Blame two years of drama from the European Union debt fallout. Heck, blame the poorly handled Facebook (FB) IPO! Whatever, right? An investor should have three basic analytical skills at their disposal when the going gets tough. These basic survival skills are: dissect (company results); connect (build a future story for the company); and come correct (with an understanding and respect for present trading conditions in the market).

Allow me to illustrate using Pier One Imports (PIR). To the casual investor, this company had a rip-roaring quarter that was worthy of hitting the "buy now" button on the TD Ameritrade interface.

Dissect

Same-store sales: Pier One's first-quarter same-store sales increased by 7.2%, but it was a slower rate of growth as compared with the 10.3% result achieved a year earlier. In my view, sales were driven more by higher customer traffic to the stores than they were by average ticket amount. Remember this thought as we shuffle along.

Gross margin: Also in the first quarter, Pier One showed a 150-basis-point improvement from a year earlier, a strong performance relative to other home-furnishing retailers in that period. However, the majority of the margin expansion was related to "leverage" on occupancy costs with the same-store sale increase. Think about concept of "leverage" existing even though a company's sales are robust enough to be spread across its cost and expense lines, with a nice chunk of those sales flowing into the profit lines. Meanwhile, merchandise margin, another component to a retailer's gross margin, only rose 40 bps years over year.

Connect

The company produced these financial results against a backdrop of solid consumer confidence, generally rising stock prices, and employment gains (though sales growth was slower). What should be internally pondered is this: Are these results -- declining stock prices and a weakening macroeconomic story -- sustainable in the present economic environment? If not, has valuation accounted for the ongoing external adjustments?

Come Correct

The market at present continues to see a greater degree of bad than good in corporate earnings reports. For example, I read Pier One's report in the following manner. Same-store sales will slow further, reducing cost and expense leverage. Promotions will have to be ramped, which will hurt merchandise margin, and second-half earnings estimates -- which are currently bullish -- are at risk. Although Pier One is best in show, I am having a difficult time telling clients to buy now.

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