Prepare Early for Earnings

 | Dec 26, 2012 | 9:00 AM EST  | Comments
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Here we are, having just finished opening the gifts and digested our turkey and egg nog, and harsh reality must intrude. I am not referring to the fiscal cliff, which of course will capture the headlines for the rest of the week. While the decoy debate continues in Washington (and Hawaii), real companies are operating in the real economy, attempting to earn real profits, which will support real stock prices.

Along with profits come profit warnings, and in a week we will be entering "pre-announcement" season, that sad time of the quarter when management teams confess that earnings are not going to meet the Street's expectations. We might get a few before Dec. 31, since the Securities and Exchange Commission (SEC) requires that any material change in outlook be disclosed when known. However, most management teams are aware of the implication of blowing up their stock price right before quarterly and annual fund performance is calculated...and right before annual bonuses are calculated.

There is no better way to garner the favor of Wall Street than to avoid potentially causing your shareholders to lose that annual bonus. (And lest you think I am overreacting, I had a colleague who once lost his annual bonus because a pre-announcement from CA Technologies (CA) on the last day of the year swung his fund from outperforming to underperforming. They couldn't wait a couple days. Once you lose a year, you do not get it back.) So, among the companies that will miss, the vindictive managements may announce it this week, but most will start pre-announcing next week.

The more important point is how to avoid owning those names that could blow up on you. The revision trend in earnings-per-share (EPS) estimates is a great starting point. Below is a list of names whose fourth-quarter EPS has been revised down greater than 10% this quarter. These are names you probably shouldn't own -- or if you do, you better have a high conviction reason to do so.

I found two surprises that stood out while I was compiling the list. First, I was shocked at how long it is. Typically, I see 50 or so names with that magnitude of downward revision. The length of the list gives me pause. Perhaps the economy is not as good as consumer sentiment indicators and the like would imply. Second, I was surprised by how short the retail list is! Late reports are that this will be a weak holiday season, so retail should be a minefield. Having said that, actual performance is only half the equation: Expectations are the other half. Clearly analysts have been worried about the environment, so, quite possibly, expectations are already sufficiently low that anything short of a disaster could support retail stocks.

Here is the list. Study it closely during this quiet time between holidays!

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