On UPS, Trust Yourself, Not the Crowd

 | Jul 29, 2014 | 3:00 PM EDT
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I once had a conversation with a professional gambler who made money from betting on horse racing. He explained what he believed was the biggest mistake that amateurs make in that game.

They believe, he maintained, that the odds of a horse, rather than their own research, indicate the likelihood of its winning. Thus, when their analysis points to a long shot, they bet less than they would on a pick that was arrived at by the same analysis but was a favorite. To him, this was completely backward. If you had used the same criteria each time, doesn't it make sense, given limited resources, to bet more on the 10:1 shot, where the potential reward was huge, than on the 2:1 shot?

Logically, this approach makes perfect sense, as presumably both selections, arrived at by the same process, have an equal chance of winning. It is irrelevant that other people can't see that, and therefore one has a bigger price than the other. As I said, that is logical, but it takes an enormous amount of confidence in your own research to bet accordingly.

Those who trade and invest often face the same problem, but in a different way. Sometimes our analysis of some news or data points one way, and we watch as the market pushes the stock in the opposite direction. That should mean that we stand to make more from our analysis than before, but in that situation we usually hesitate or abandon the trade altogether. Consider the second-quarter earnings release of United Parcel Service (UPS).

UPS announced earnings per share of $1.21, compared with a consensus estimate of $1.25, and lowered full-year guidance below expectations. Revenue, however, was better than expected at $14.26 billion, compared with a $14.1 billion estimate, and management pointed out that the difference was due to increased investment by the company. In the words of CFO Kurt Kuehn, UPS is making investments that "will increase operating expense this year, but will provide financial benefits for years to come."

Surely, since the package delivery market is set for continued long-term growth as Internet retailing grows, and since UPS has acknowledged that it missed some business last holiday season because of lack of capacity, that has to be a good thing, right? Aren't analysts always complaining that CEOs are too short-sighted and concerned only with quarterly profits, not long-term growth plans? The market's reaction to the news from UPS shows why CEOs often think that way.

As you can see, traders greeted this particular bit of news about a company investing for the long term by pushing the stock down more than 3%. As I saw that, I started to doubt my own analysis. Obviously, I was wrong and the market was right, I told myself, but why?

It could be to do with positioning, I thought, as the stock has been climbing for about six months. Maybe those longs were getting nervous and sold at the first sign of weakness, but in that case it would be logical for it to bounce straight back. It could even be that everybody made the mistake implicit in this Reuters piece picked up by CNBC and compared the $0.49 EPS after an expected charge relating to retirement obligations with the analysts' ex-items consensus of $1.25, and concluded that the wheels had really come off. But somehow, I doubt that.

The more I look at it, the more it looks as if this drop in UPS simply represents a great opportunity to buy the stock as a long-term investment at a discount. Like the horse bettor who likes the 10:1 shot, I should trust my own analysis, not the wisdom of the crowd that has set the price, and take advantage of the prospect of more profit that that price affords. This time, I intend to do the logical thing.

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