Thursday, 25 October 2012
The Day Ahead: The Perils of Bottom-Fishing
By choice, I will stitch together earnings-season notes and play in Excel from the comfy confines of a space no bigger than a restroom in a one-bedroom apartment. To some this would appear akin to self-torture, but to me if offers a physical bubble around any harmful toxins that want to enter the analyses I'm conducting. Stupidly, I allowed a toxin to cross through to the other side on Monday evening, and its name was "Bottom Toxin." After the Dow gagged Friday, we've heard that the world's economic growth rate is now bottoming, and we must quickly welcome an array of earnings-season violators into the portfolio -- or, if you are me, onto the client watch list.
Snauseges? I comprehend that everyone in the #FinServices sphere wants to be the next rock star, that person of perfection who predicts that a market or a stock will likely head higher or lower by 10%. Sure, my dudes, we have to justify fees, be they for execution (research is an add-on, the ultimate "intellectual capital") or some other business being promoted through Google'sGOOG search algorithms.
But as a person who has been trained to first-smash a company's fundamentals into small pieces and then be the pitchman for or against exposure to the stock, I have to ask this simple question: Do the masses truly grasp the characteristics of a "bottom" in a company's performance or in country's economy? Further, for those identifying bottoms all over the place, I fancy there should at least be more than a few data points to support the brick-laying that are alleged to have brought us to financial spoils.
I took a momentary trip to the "bottom," and this is what I learned.
A Bottom, Deconstructed
● Pricing power is hard to come by, as companies become promotional to maintain market share. If Company A is ramping promotions, best believe that Company B and Company C will promote. Inside of that, it's hard to tell which company is winning and with what detriment to margins. Specific to this earnings season, the chatter was that third-quarter profit estimates would be eclipsed with ease. Guess what? That isn't happening, and it's starting on the top line. Are you willing to model for an expansion in the price-to-earnings multiple in this scenario?
● There are excess goods sitting in end markets. This leads to a mouse-eats-snake development as goods bulge in factories and stockrooms. In upcoming 10-Q releases, skip to the inventory section and target the "finished goods inventory" component -- it's unlikely to be pretty for many companies that had earnings shortfalls. It requires time to sell off products collecting dust, even if a price discount has been enacted.
● There is this natural tendency for executives to believe an improved macroeconomic environment will alleviate the aforementioned issues, but they are hesitant to share this with analysts and shareholders for fear of over-promising and under-delivering. As a result, we are left exposed to potential false reads by the market -- as is currently the case, with stocks reacting harshly to earnings misses.
These are the primary takeaways to my trip to the bottom. I don't want to completely ruin your day with zillions of earnings bullets flying by. You see, the bottom is an ugly place to be, a barren wasteland where the slightest bit of rain brings hope. Stock-pickers will play with their discounted cash flow models, modeling in "reasonable" free cash flow and P/E multiple assumptions -- yet there is no real assurance they are reasonable enough.
At some point, yes, we will have to circle back to the industrial complex, call the big names oversold and then plunk down wagers on brighter quarters in 2013. However, I remain hesitant to call that in names such as Caterpillar CAT and Texas Instruments TXN , as the market is not telling us that should be the game plan right around now.
Caterpillar traded off the lows of the session in response to earnings. If that was a type of stealthy bullish tell, am I a complete whack job in saying that the action should have spilled over to comparable companies in industrials -- for example, General Electric GE ? Heck, shouldn't the stock have closed at session highs? Theoretically, if a name like Caterpillar is moving counter to conventional wisdom -- that the world stinks -- then sentiment must be mirrored elsewhere in terms of sectors.
On Sept. 5, I said this on Decker's Outdoor DECK : "I'm not feeling how its outlook is shaping up on cost of goods sold, nor on what this means to consumers." On Oct. 23, I say this: Stay far away from this stock. Holiday-quarter guidance will be slashed, inventories are likely to be elevated (again), and core Ugg brand sales will be weak. But why stay far away? Well, there is an outside chance lower prices cleared some excess inventory, and that could trigger hope consumer appetite still exists for the brand -- which would crush the shorts.