Ah, earnings season is truly upon us. It's time to talk about the truth of this moment when we grade companies. These moments when the reports come fast and furious, one after another, with headlines blaring and pre-market trading all over the place, are the most challenging of times.
The main reason? Subjectivity. I regard the grading of companies pretty similar to the way teachers administer tests. We have the true-or-false quiz, we have the multiple-choice test and then we have the paper, the subjective paper that has to be read from beginning to end to try to figure out exactly how well the company really did.
So we can hear that such-and-such a company reported a good quarter, but I like to reserve judgment depending on the kind of test that's administered.
Sometimes the answer is obvious. Johnson & Johnson (JNJ) had a monster quarter with beats on the top and bottom lines and stellar sales of all of its new drugs. It was unassailable. This was a true-or-false test, checking "true" next to the line that says "JNJ Was Fabulous."
Netflix (NFLX) , on the other hand, had a flop of a quarter, a big miss in subscriber growth as those who had been given a grandfathered price break reacted negatively to the end of the price breaks, or the un-grandfathering as they awkwardly referred to it on the call. Netflix is the answer to a multiple-choice query about which company has had the worst report so far this earnings season.
But how about IBM (IBM) ? Ah, this one's a paper that needs parsing. And it totally depends on who is doing the grading. When I went through the quarter, I pretty much liked the growth in the proprietary cloud and cognitive data businesses, the ones that involve Watson, which you have no doubt seen on television. That business is becoming more and more of the company and, at more than $30 billion in sales, or 38% of the pastiche of the entire panoply of businesses, you have to be encouraged about the transition.
However, then you listen to Toni Sacconaghi, the incredibly rigorous analyst at Sanford Bernstein, and he point-blank says the company's businesses are decelerating and they are going to be hard-pressed to make their numbers in the second half. He thinks the company took a step back, not a step forward, in this last quarter and he makes a very compelling case to stay negative on the name.
Given that the company's stock had run into the quarter, the balance of evidence goes to Toni and he's sitting on the stock. Had he upgraded, something that I thought might happen given his respectful tone on the conference call -- he had become pretty boisterous, to say the least, on previous calls -- then I think the stock would be flying. So, in this case, good call for some, not so good for others. I thought it was a B-plus; he flunked it.
But then there's United Health (UNH) , which had a gigantic beat, a buck ninety-six when the Street was looking for a buck eighty-nine, and its commentary in the release read spectacularly. Plus, we know that United Health has pulled out of a lot of the Affordable Care Act exchanges because they have been tough places to make any money at all. But the patients are costly because of higher disease prevalence and the company is also boosting how much it spends on hepatitis drugs.
Not a great quarter, especially given how it has run. Not a bad quarter given how good it really was regardless of the Affordable Care Act issues. It started as an A and morphed into a B.
Goldman Sachs (GS) totally and completely clobbered the number. Just magnificent: $3.70 v. $3 per share. The problem is it has run from $144 to $163 in advance of the quarter, in keeping with the much better numbers we saw from JPMorgan (JPM) , Citigroup (C) and Bank of America (BAC) . So it was real good, but not good enough, especially with expense control, which I regarded as marvelous but the rest of the Street didn't. I swear this one was a good quarter. But I am not the grader. Goldman deserves an A, but it's a bell curve and that grade went to JPMorgan. It ended up getting a gentleman C. (Citigroup is part of TheStreet's Action Alerts PLUS portfolio.)
How can you tell what kind of test you are being given? And what can you do about it to maximize your profit while minimizing your risk?
There are a couple of lessons here.
First, when a stock has run up, the important thing to remember is that there are people who are in it for the quarter and they are going to blow the stock out no matter what as a discipline. Traders have a big gain, they should and will take it. They aren't even waiting for the test results.
Second, there are people who are more powerful than the company itself in determining the stock price. Sacconaghi may be a guy who means nothing to you, but at this particular moment he is every bit as important as CFO Martin Schroeter, who runs the call. If he doesn't like the quarter, if he says IBM can't make the numbers they have laid out, if he says the business isn't transforming the way IBM says it is, then his voice is going to predominate. He is the ax. He is all-powerful. Does he deserve it? I think he's earned the right to call 'em as he sees 'em and that's what he does. Plus he is a well-liked and respected guy, not a pop-off, so he is going to have that strength and that gravitas.
Third, this is a relative game. Goldman Sachs may report a very good quarter in absolute terms, but it is the relative that matters. The quarter simply wasn't as good as JPMorgan's and yet it had run a commensurate amount. Now, to say this company did as well as Citigroup is a little crazy, but the fact is that so little is expected from Citi and so much is expected from Goldman Sachs. Right now, I think Citigroup's the buy given how far it has come, but I simply don't believe Goldman Sachs is bad, either. It's just that it's not good enough. In a vacuum, I think Goldman would be soaring toward its book value of $176 -- basically the cash that is on hand -- but the grading is subjective and the teacher is overlooking that objective fact.
Fourth, when it's bad, it is really bad, more than one day bad. Flunking bad. Netflix is one of those kinds of bads. When you see a stock down this hard, you have to believe there are multiple institutions that are trying to get out of it and they won't be able to do so all in one day. They own too much stock. There were enough downgrades and number cuts that this stock might not be able to sustain even these prices.
But when it is good, it is so good there is simply no price people won't pay for a stock. Johnson & Johnson's earnings were that type of good, and now you have to wait for the next Brexit before you get a chance to be able to purchase it at a discount. Summa cum laude.
Finally, we have to remember that headlines can be the great American fake-out. The most compelling headlines of this morning, the ones that blew me away the hardest, were from United Health, which is a fantastic health insurer and health maintenance organization. If you owned it, you had to be cheering. But the conference call gave you the other side of the story, that there is some hair on the quarter, as we say. If you traded it before the call, how can I say this pointedly? Shame on you. You don't deserve to be a trader. If you don't have the patience to listen to the call, you shouldn't be managing your own money. I'm failing you right here, even though you aren't even in my class!