The Day Ahead: The Sights and Sounds of Earnings Season

 | Jul 25, 2012 | 8:30 AM EDT
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It was Tuesday afternoon, and there I stood in front of a television camera, decked out in makeup and a bright purple skinny tie. I had my topical information down stone cold -- it was to be instant earnings analysis on Netflix (NFLX), Panera Bread (PNRA) and Apple (AAPL), sprinkled in with assorted chatter on this wacky stock market. Then, ka-pow, news crosses the wires that the Federal Reserve is inching closer to enacting the market's favorite three-letter economic help program known as QE3 -- that is, a third round of quantitative easing.

Initial thought: "Hmm, now I get why the futures massively reversed while I was sitting in the green room." As I provided a quick assessment on the shock factor of this latest life-altering development, the inevitable dawned on me afterwards. First, QE3 would not fix iota of what I am seeing in second-quarter earnings and hearing on conference calls, and that goes for full-year outlooks as well. Second, investors must be very careful not to divert from winning strategies following a story that was absent quotes from Fed members on precisely the reason for the market's reversal -- the prospect of QE3 at next week's Federal Open Market Committee meeting.

When it comes to investing, I believe a few things at this point. First, there are individual success stories to be bought, and a worthy simple screen to run is any company with under 40% of its revenues derived internationally. Once those results are yielded, make sure the percentage of sales from the international scene is at least 10% or more weighted toward Asia. That area of the world comprises economies that, while they're slowing in growth rates, do offer an offset to a company's likely horrid European profit margins. Second, realize that the screen will leave you with predominantly a U.S.-centric business at risk of surprising to the downside in the third and fourth quarters, given an array of macroeconomic issues.

Basically, what I am saying is that your portfolio has to be actively managed. It's unacceptable to buy into the crowded dividend-payer trade and hold to forever, because the underlying company is probably a slow-growing multinational.

The slow-growing aspect is a function of unimaginative products -- for example, packaged food -- on which investors depend to drive sizable volume to balance weak gross profit margins. This is meant to create upside potential to operating profit margins and earnings through free cash flow that's spent on share repurchases. Under Armour (UA) wins over Nike (NKE), as it's a U.S. business with multiple product platforms for growth. McDonald's (MCD) looks less appealing compared with Panera in this need to actively manage world.

In the end -- meaning today -- weakening corporate fundamentals have to be the numero uno focus for you, as opposed to a headline bomb tossed into a weak tape. These are some sights and sounds of earnings season this week. Add them to the laundry list of notes scribbled from today's morning reporters.

The extra-bold outlook: Panera actually expects acceleration in its earnings-per-share growth rates in the fourth quarter vs. the third quarter. If unfavorable macro data mount in coming weeks, look for the market to reverse Panera's earnings pop on an assumption that the fourth-quarter earnings outlook is too optimistic.

The luck-pushers: Chipotle (CMG) was on a price-hike campaign in 2011, and ditto for Buffalo Wild Wings (BWLD). Now, with consumer spending moderating (despite gas-price relief), there is a realization that prices for certain goods or services just "feel" too high. That, in turn, leads to lost sales. I will lump in Whirlpool (WHR) here, as well, as it underperformed U.S. industry shipments in the second quarter following hefty cost-based price increases.

Understand what a product does: Under Armour was quite proud of its footwear sales performance, as it should be. However, it's a lower gross-profit-margin business for the company, as compared with apparel. The trick is this: A greater volume of footwear, against a generally fixed-cost base for the product, is good for operating-profit margins. But, should the economy grind to a halt in 2012, Under Armour will be left with high inventories of low-margin product that is destined for factory-store discounts. This would obviously be an unwelcome occurrence, and one that would get me thinking about a Nike amid a better, more diverse product mix and subdued market sentiment on the name.

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