A key component to the research I do on companies, other than chatting with execs and running roughshod at stores with an iPhone camera, is lay-of-the-land analysis. To me, this involves getting a feel for the operating environment of the company and news flow, along with the market's latest reactions to both. A company could be killing it operationally, beat earnings targets by $0.05 per share in a given quarter, yet its stock could plummet due to reaffirmed guidance. So I always try to reduce the risk of such for clients by conducting that kind of analysis.
After surveying the scene this past weekend, I have to admit: The lay of the land kind of stinks. So, ahead of the newest earnings season, I've forged three new rules to live by. Heed these warnings, or else.
1. Companies are underperforming, so assume the worst. Yes, there will be pockets of greatness in industrials and tech. But we've also witnessed material earnings-per-share warnings from a host of consumer-facing companies, such as Express (EXPR), Lululemon (LULU), Target (TGT), and this all carries direct implications for various S&P 500 sectors.
Despite the re-accelerated gross domestic product growth in the fourth quarter, do not assume a company you own -- or are looking to own -- will now flourish more than what was suggested by its third quarter or its so-so full-year outlook. In fact, assume the worst, unless a company has entrenched positive trends (such as a robust backlog), and check your risk exposure in the portfolio. Companies are quite simply failing to meet low expectations.
2. Not so fast on the buyback assumptions. I am fully aware that you're probably not modeling future earnings in an Excel spreadsheet. Nonetheless, here's some advice if you are buying a company's stock in hot anticipation of a massive new buyback plan running through the newsfeeds: Beware, champ. I believe many companies are preparing to further reduce excess capacity (aka restructure) with cash on hand, and that this will potentially whack stocks that had priced in a certain level of share-repurchasing. Not all stocks will react like Macy's (M) did when it recently shared a major new restructuring plan.
3. When a bad company's stock pulls back, assume it is not a once-in-a-life-time opportunity. You have probably been brainwashed into thinking that if a stock falls in excess of 5% on earnings day, it's a can't-miss buying opportunity that could enrich future generations of family members.
That is the wrong mindset to have, guys and gals. I have detected that, when a company issues a material earnings warning in the current operating environment, most of the time it could take an extra quarter or two for the business to turn around enough for you to even consider buying any deep share plunge. Otherwise, assume a significant earnings-triggered stock decline is a sign that the future is not as fundamentally bright as it had been the day before.
On Monday, my firm went live as an official member of the Wall Street consensus. It's pretty darn exciting and special, and something I take very seriously. First call: a downgrade on Starbucks (SBUX). Today, we are also out with a reiterated Sell recommendation on Target.