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  1. Home
  2. / Investing
  3. / Industrials

High-Quality Stocks Take a Hit on Lofty Expectations; These 2 Could Be Next

In this market looking for quality, even the best companies can hit a ceiling.
By JAMES GENTILE Jul 22, 2016 | 10:00 AM EDT
Stocks quotes in this article: SHW, GGG, LII, AYI

Earnings season delivers unnecessary volatility at times. But this period, four times per year, also serves as a near-term check and balance to keep expectations in line. As much as all of us like a straight line, with minor jagged edges, moving "up and to the right" in perpetuity, that is simply not realistic.

Some high-quality stocks have gotten hit this earnings season, and not necessarily because these companies are unraveling -- not at all. Simply, the realities of a choppy and slow-growth economy are not necessarily reflected in estimates and valuations have expanded among the highest-quality companies.

Sherwin-Williams (SHW) reported a decent quarter, but slightly missed estimates and the stock went down. Nothing wrong there. Just near-term expectations that were too high, and with the valuation on the stock expanded, an acceleration was needed to keep pace.

Then there is SHW's little and high-quality brother Graco (GGG) . I love this Minnesota-based company. Graco generates super high margins and returns, international growth and strong R&D for a manufacturing and supply chain franchise -- all with consistent free cash flow conversion. But in this market looking for quality, even the best companies can hit a ceiling.

Similar to Sherwin-Williams, Graco missed lofty expectations. The company's process segment is still hamstrung by weak oil-and-gas spending, something that should have been factored into the consensus framework.

In any case, these are two of the highest-quality growth companies, and their shares are under recent pressure. Fortunately, they are at more attractive accumulation points.

Perhaps other high-quality consumer and industrial-type cyclicals, ones that have recently performed well, will see similar pullbacks.

I call your attention to Lennox International (LII) , which is notching new all-time highs after this quarter's solid release. There's nothing wrong with anything at this company, of course. It's just priced for perfection, although to be frank, I thought that $20 or $30 ago.

Another powerhouse, Acuity Brands (AYI) , is executing flawlessly. Nothing to see here, yet, but at least two-thirds of Acuity's business has some level of cyclicality. A rich multiple could be vulnerable should execution hit a speed bump, or if comparisons get choppy into 2017 -- a very possible scenario.

So I'm just watching the charts on some of my favorites and sharpening my pencil for entries or trading shorts. SHW and GGG are closer to being longs, while AYI and LII should probably be reduced.

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At the time of publication, Gentile had no positions in the securities mentioned.

TAGS: Investing | U.S. Equity | Industrials

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