Ever since I entered financial services, I've been quietly searching for a short book titled An Investor Guide to Earnings Season -- but no dice. Maybe there are chapters in certain books dedicated to the subject, but there is really no defined roadmap to successfully navigating earnings season, and that speaks to the dynamism attached to this month-long stretch of intensity.
As a result, I have developed my own set of procedures to follow throughout a typical reporting period, and I do the very best to share them with you when all goes haywire. This time around, as I pointed out in Tuesday morning's column, earnings season has largely been chock full of confusion thus far, thanks to macro issues that had been lurking in the weeds. Here are two of those issues.
China: Other than China's decision to widen the trading band on the yuan, we no longer hear about talk on the country's economic hard landing, soft landing, crash landing or hovering two feet from the ground, as it were. This is indeed a welcome development -- because the mood of the market, as I interpret it, now figures the probability of a soft landing has superseded the alternative. Muhtar Kent, CEO of Coca-Cola (KO), appears to support this idea: He flat-out stated that growth in China is moderating, and that it's likely to continue down that road this year, which he said should "moderate" the company's volume "to some extent." In other words, he doesn't expect volume to be hammered -- and that's key language to hear from a multinational with deep, global tentacles.
QE3: Where has the discussion gone on another round of quantitative easing from the Federal Reserve, or on the central bank shaking the hands of policy hawks and lifting rates before 2014? The banter has subsided, and this is good for stocks -- for now. There is a Federal Open Market Committee meeting scheduled for next week, and if talk stays dormant into Friday, it will only ratchet up the surprise factor -- whether it's positive or negative -- to a statement that technically should not bring any surprises.
Most important, in my opinion, is that earnings season has found its rhythm. Every season has its own feel to it, where a certain "must know" and "must appreciate" line item or corporate comment just flies from the 8-K SEC forms. I always fret over maintaining my feel for the market, especially during earnings -- but, luckily, I have found this season's groove.
Volume and price: I believe it was a week or so ago that I highlighted volume trends as a crucial item on which to focus. Pricing was less of a concern in light of softer-than-expected U.S. data and rampant concerns on demand in peripheral European Union countries and China. Volume has been the star of first-quarter earnings season, with Coca-Cola logging it overall -- and in Spain, in fact. W.W. Grainger (GWW) printed 10% volume growth, and CSX (CSX) implied its top line was more a function of volume than pricing.
However, if volume is has been the Batman of the quarter, then pricing has been a surprisingly adept Robin. Companies are telling us opportunities exist for marking up prices. In fact, in the case of W.W. Grainger, management said that pricing actions completely counteracted cost inflation. Not to be outdone, Coca-Cola, which operates in all sorts of competitive drink categories, had a 3% favorable price mix comparison. CSX likewise continued its run of positive pricing. Away from these names, even, banks have seen interestingly solid commercial loan and mortgage banking volumes.
Am I sounding enthusiastic? Sure -- why not? These are facts that I don't believe the market was expecting pre-earnings -- I certainly didn't see any mention of it in analyst estimates. Basically, corporate America is saying its real-time business trends are perhaps stronger than what the market priced in months earlier, and that it's undeserving of this back-and-forth dialogue on a correction. It's ultimately news such as this on which the market will lean during the lull between reporting periods.
Share repurchases and dividends: Coca-Cola plunked down almost $900 million to buy back its pricey stock in the quarter, and banks are coming through with the dividends -- if their name is not Citigroup (C), that is. I don't believe we have seen aggressive use of cash rich balance sheets yet, but that may be a reflection of the composition of companies that have announced to date.
Of course, there were some yellow flags. First, while full-year earnings ranges are being raised to account for first-quarter upside, these moves haven't constituted anything in the form of resounding second-half optimism (see W.W. Grainger). Coca-Cola stated it's "cautiously encouraged" -- a new twist on the overused jargon "cautiously optimistic" -- on the full year.
Second, stocks have been trading lower or only up slightly on seemingly positive news and commentary. That's disappointing, and it hints at low-bar-setting into the second quarter. I would like to eye pops in response to a solid beat, or a revenue raise by a company like Intel (INTC), without having to understand the market's unintelligible misgivings with the numbers.
Be a Player, Not a Hater
If the market is so disinclined to reward individual company performance, who am I to stand in front of it? Do be careful, however, as many names in many sectors continue to sport broken charts -- for instance, the stock may still be trading below key moving averages despite the broad market's bounce. Moreover, there is a fair number of "head-fake charts" on the scene. In other words, the stock has rebounded alongside the market and is back above a moving average, but on unconvincing volume.
No other sector exemplifies these trends better than retail. If you wish to join the fray in this sector, there'd best be intriguing fundamental factors at hand, in addition to attractive valuation. Clothing chains Limited Brands (LTD) and Chico's (CHS) are two calculated-risk calls of mine. Limited Brands shares are pricy, but the fundamentals of the business warrant the premium. Furthermore, the stock yields a shade more than 2% and, between now and the summer, one cannot rule out the potential for the surfacing of Limited Brands' patented special dividend announcement.
As for Chico's, the stock appears too cheap to me. This is first based on its assortment this spring, as well as on more concrete elements, such as rising full-price sales at the White House Black Market and Soma divisions in the competitive holiday quarter. In addition, Chico's has seen only modest gross margin degradation in the face of cotton cost pressures in the second half, and it sports controlled core inventories (excluding stock for new stores and average unit costs).
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