As we enter April, inquiring minds start contemplating the upcoming earnings season. Most important, will earnings growth live up to the high expectations set up one of the strongest rallies we have seen in quite some time?
Most analysts and portfolio managers find earnings season interesting, but I am more interested in pre-earnings-announcement season -- that first week after the close of the quarter when the tide goes out, and we find out who is swimming naked. By definition, these announcements are generally bad for stocks, because they represent business performance that is missing (perhaps) already low expectations.
While a profit warning does not automatically mean a stock will crater -- sometimes they are so washed out it doesn't matter -- it usually does mean poor near-term and longer-term performance. One simple rule for making money in stocks is to avoid names in which earnings are coming in below expectations.
One tool that I use, which is an adjunct to fundamental research, technical analysis and so on, is to look for declining earnings estimates. For areas in which analysts are cutting numbers, you can figure that the incoming inputs are not particularly good, and the stock is ripe for a miss.
I ran a screen of companies that have seen significant cuts in their first-quarter earnings per share estimate during the quarter. This "Hall of Shame" includes names that have a higher-than-average likelihood of pre-announcing a miss in the coming couple weeks.
The list shows representation from almost every industry. It's important to note that this is a very short list for companies whose estimates were cut at least 50% during the quarter. Using a wider screen, say of 20% cuts, creates a far larger list. (Email me if you want that table.)
Some names are not surprising. For instance, Alcoa (AA) has been under pressure for some time, and high jet fuel pricing is killing Southwest Airlines (LUV). Seeing Amazon (AMZN) here is amazing, given the magnitude of the EPS cuts -- $0.40 down to $0.06! CIT (CIT) looks like a total disaster, but that one may end up in the already-washed-out category.
We'll revisit our list in a couple weeks and see which names issue pre-earnings announcements. Whether these ultimately do or don't, they are candidates to avoid -- when estimates are being cut, that tends to almost always equals poor stock performance.
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