It's Not Always About Earnings

 | Dec 13, 2013 | 11:42 AM EST
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Know your metric! Last night, Adobe Systems (ADBE) reported a quarter that looked like it was from Hades, and sellers dashed out of it, on the basis of what looked to be a serious shortfall. I know I was crestfallen when it came out, because we own it for the Action Alerts PLUS charitable trust, and I didn't want the trust to get hit this close to year-end. I don't throw things anymore, but it was upsetting, as it always is when one of your stocks is trading down in afterhours. You feel helpless and befuddled, knowing that the night and the next day's trading are going to be hideous.

Wait a second, said Stephanie Link, my co-portfolio manager, you know we have been telling people that this stock trades off the cloud orders, the new lucrative subscription suite offering that has ignited sales and will be a big part of the earnings stream in the future.

I said to her that everyone knew that and they don't seem to care, as they are selling it down anyway. She challenged me and said they are selling it down precisely because they don't know that the earnings per share are not what controls. Plus, when a stock heads down, it is a self-fulfilling prophecy, as the media then jump all over it, accentuating the horrendous shortfall and the big, big miss that has made it the disaster du jour.

Sure enough, what we were looking for, the subscription orders, were far better than what we thought. Initially, as you watched the stock tick up, you could see that those who were selling it on earnings were confused. The climb made no sense to them either, because they were using a service that told you what the earnings-per-share consensus was, and it didn't hit the consensus, so therefore that meant sell. Or they weren't on the conference call at all, or else they would know that the key metric is so much better.

Next thing you know, the stock is up 2 and a half from the bottom as management outlined the cloud business, and then it jumps another dollar when they get downright giddy about the company's success in transitioning to cloud-based orders.

By that point you know that the shorts are so baffled that they simply have to cover, and that has led to the huge run higher that you can see on your screen.

Now, I have been a huge proselytizer for waiting to hear what a company has to say on a call before taking action. Sure, there are cases where things are bad, and when the company fleshes it out on the conference call, the stock gets hammered once again. That's exactly what happened to Cisco Systems (CSCO). But waiting to hear the real story has, on balance, been much better than worse in the years of the conference call's ascendance.

Even more important, though, is the recognition that not every stock is an earnings-per-share-driven stock. In my soon-to-be for sale book, Get Rich Carefully, I give page after page of key metrics that are the real drivers of what must be beaten to send a stock higher. We know now that the sellers of Adobe didn't see the truck coming that ran them over because they simply believed that investing is as simple as finding out what the EPS consensus is, seeing if a company failed to beat it, and then shorting it to Kingdom Come. I wish it were that easy.

The hard money, the careful money, was made knowing what really mattered with Adobe. Only those who know how to do the homework could reap the rewards of the turn in Adobe's stock. Be sure you know what can affect a stock more than earnings per share before you come in with guns blazing. Believe me, you won't regret doing the extra work. If you don't do the homework, just say away from your screen. You will be beaten to a pulp the way the Adobe Quick Draw McGraws were off this outstanding quarter -- at least outstanding in what really mattered.

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