Management Reigns Supreme

 | Oct 24, 2013 | 3:37 PM EDT
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Tech's bad. No, tech's good. Oil's bad. No, oil's good. Housing's horrendous. No, housing's good. The transports are awful. No, the transports are terrific.

Or maybe, just maybe, we should dispense with the labels and talk about management, companies and execution.

This earnings period we have seen a remarkable divergence within sectors. It's so stark that we have to call into question the financially engineered exchange-traded funds that are meant to allow you to "play" a sector rather than invest in individual companies.

We've been so lulled into believing that stocks in a sector should all trade in unison that we are missing important opportunities to own the stocks of companies that are delivering and not just flit through ETFs meant to capture moves. And we've become conditioned to playing certain stock trends that we forget that sometimes the company's facts get in the way of the story. You know why? Because management's performance varies tremendously -- some get it while others don't get it at all.

Let's take the most glaring example, Caterpillar (CAT), the gigantic construction equipment concern. We know that residential and non-residential construction is coming back in this country. We also know from data out of China that the People's Republic, despite an aberrant number here or there, is actually doing much better than we thought. So, what do we want to do? Who has fingers in both pies? How about Caterpillar? What a great way to play the turn in residential and non-residential housing here and a return to growth there, right? There's only one niggling problem: Caterpillar reported a hideous shortfall yesterday and cut guidance gigantically. That's how a stock goes to $83 from $89 in one day. Caterpillar has become incapable of doing its job, and is certainly no way to "play" anything other than the current incompetence of the team running this great American company. Sure, it's in all the right markets and it does an excellent job telling you how those markets are doing. Unfortunately, it is executing so horrendously that it cannot be owned and it doesn't even seem to listen to its own advice about what's happening in the world.

It's the wrong way to profit off the resurgence in construction both here and in China. But how about approaching things more methodically and rigorously than just slotting in some company that makes good products and sends them into both markets?

You want to own the best of breed in commercial and residential construction in the U.S.? Then buy United Rentals (URI), which is a huge equipment rental company that's become the de facto way for builders to get their construction equipment. It's cheaper, it's more discrete and it's incredibly well managed (I just spoke to them last week on Mad Money), and the story's terrific.

And you want China? That's easy. Buy Cummins (CMI), which is the fabulous truck-engine company that is executing fabulously in China and blowing away the competition in the People's Republic. You are betting on the wrong horse with CAT.

How about tech? Earlier this week Altera (ALTR), a semiconductor company, reported a miserable quarter and this market instantly took down the entire semiconductor cohort. You know what was particularly hard hit? How about Lam Research (LRCX), the semiconductor equipment company? But these companies aren't homogenized like milk. Today, a day after being smashed to bits, Lam Research is on fire, up $1.52 as this Action Alerts PLUS name reported a fantastic quarter. It had no business going down with Altera whatsoever.

You think that oil's going to rebound after a week's worth of weakness and you want to own an oil-services company to trade the move? Aren't they all the same, though? Does it matter? Ask the people who bought Cameron (CAM) and Diamond Offshore (DO), which are down $9 and $1.70, respectively, as they executed so poorly that it takes your breath away. Then how about Charitable Trust holding Ensco (ESV), a company that many thought would miss the quarter and guide earnings down sharply. Nope, it beat the number and affirmed guidance and its' hanging in there just fine. The stocks were trading incorrectly going into the quarter. Totally. Their prices made no sense at all.

You want case-by-case? Check out the rails. I am a huge fan of Union Pacific (UNP) and I was buying it for the Charitable Trust in the low $160s and high $150s. The company had been signaling things were robust. But things got weak and next thing you know the company preannounces a weak quarter, citing coal loadings among other things. Immediately you saw tremendous short-selling in Norfolk Southern (NSC), which has even more coal exposure than Union Pacific. So what happens when it reports? The company executes amazingly and the stock goes to $87 from $80 in a straight line. One company just performed much better than the other.

The importance of management is on display everywhere. We saw Delta (DAL) report an amazing quarter Tuesday and the stock's still running higher. But United Continental (UAL) misses and the stock just drifts. That's why Delta's up 120% for the year, four times what United Continental's gone up. U.S. Airways (LCC), meanwhile, just keeps doing amazingly consistent numbers. Heaven forbid the Justice Department allows it to buy AMR and you still might get a double.

We've seen a parade of weak housing numbers and the group has turned into a treacherous morass of disappointment. But that disappointment was too sweeping, as we are seeing from PulteGroup (PHM), which is making a huge amount of money per house because it is concentrating on margins, not just putting up and selling houses wily nily. We were looking for $0.36 and it did $0.45 -- an outstanding earnings beat. It's taking up all of the housing stocks, and that makes sense given that interest rates have been going down. What matters, though, is that the issue isn't whether housing is any good, it's who is capitalizing and who isn't. PulteGroup is making the money.

There are so many reasons why we shouldn't just be homogenizing and pasteurizing stocks as if the companies they represent are all .500 teams that can win or lose on any given Sunday. This isn't the NFL. Some companies are doing a better job than others because they have better coaches and better execution of the game plans.

Of course, there are all sorts of other reasons why you need to know the managements, not just the products or the sectors. We are watching Apple (AAPL) being besieged with kindness from Carl Icahn, who is tweeting all about how the company had better start doing something with its bountiful cash or else (although, I ask, or else what?). I just want Apple to execute on its new products and then reinvest that money in places or companies that can give us more growth. You certainly aren't going to play tech with Apple, though.

You want to invest in finance and make money? You have to avoid the lawsuits and the prosecution, which means buying Visa (V), which just gave you an outstanding 21% boost in its dividend. The typical bank these days has to have any dividend boost approved by incredibly hostile regulators.

And there are themes so powerful that you must take advantage of any dip to buy any of the major companies in the sector, as we saw earlier this week when Honeywell (HON) momentarily dipped on a very good but very misunderstood quarter, then snapped back when it boosted its dividend far more than people thought it would. At the same time Boeing (BA), which uses Honeywell's technology in its planes, blew away even the most bullish of analysts with its earnings. But the aircraft construction industry is an aberration. Otherwise, it is case-by-case for this earnings period with the determinant being management's skill, not the power of the sector itself.

The moral? Stop playing themes and start investing in best-of-breed stocks. That's how the real money's been made this earnings season. I know it's a bit of a bummer because you need to do work on each company rather than just buy the ETF and hope for the best. But sometimes this market is just like school: If you don't do the homework, you might as well flunk and stay home.



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