This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

When Bad Guidance is Good News

By Barry Randall

When is 'bad' guidance from a company management actually 'good?'

I'm faced with that question every February, as public companies report their fourth quarter earnings and managements issue (for the first time) financial and earnings guidance for the forthcoming year.

Let's say our favorite imaginary company, Polyrazzmatazz (POLY), announces that it expects to book $1 billion in revenue and earn $3.00/share for 2014. But the consensus earnings estimate at that point has them at $1.1 billion and $3.25.

Uh oh, it's the dreaded 'guide below consensus.' Bells go off at CNBC, Bloomberg and the Wall Street Journal. Pretty soon POLY is marked down five or 10 percent. Some headlines might even describe this as 'Polyrazzmatazz Lowers Expectations.'

But hey, wait a minute. Time out. Let's look at this more closely.

Suppose POLY's own 2014 expectations reflect such positives as a) accelerating revenue growth versus 2013; or b) improved operating margins; or c) an increase in the dividend yield. Doesn't sound like the company has lowered expectations. In fact, things sound really good.

So what's up here? The answer is simple: the analysts 'got ahead' of the company. The analysts were simply more optimistic about 2014 than was management. Hey, that's no crime. It's human nature. But it can lead to misunderstandings.

The analysts covering public companies typically have published estimates that look ahead 4-6 quarters. So they started publishing 2014 estimates back in mid-2013. But the companies themselves are only now rolling out 2014 expectations, because they just got done with their internal planning for the upcoming year.

So who are you going to trust? The analysts, who independently apply skill and experience and a few hints from management in coming up with their estimates? Or management, who has direct control over expenses (they write the checks) and indirect control over revenue (they hire salespeople)?

The answer is, of course, "it depends." But here at Crabtree, we place a high emphasis on companies whose managements have a history of straight shooting and keeping a firm grasp on reality. So we tend to favor what our managements say, over the analysts. Note that I wrote "favor," not "believe without hesitation."

During the most recent 'earnings season,' we got bad=good type guidance from a number of Crabtree Technology portfolio holdings, including EPAM Systems (EPAM), NIC Inc. (EGOV), Green Dot (GDOT) and Heartland Payment (HTLD). And all four made the cut during our late February re-balancing. We saw through the confusion.

But then there was long-time Crabtree holding Stamps.com (STMP), which actually offered solid guidance, but made a lot of comments about the changing competitive landscape and customer-acquisition costs going up.

Stamps.com is a great company and isn't really doing anything wrong or different. It seems unlikely that the company will surprise the Street in a way that justifies the valuation premium its shares carry. So we sold it…

Along with Spirit AeroSystems (SPR), where the analysts were out ahead of the company's initial 2014 guidance. But the company's ability to simply execute in the near-and-now is simply no longer up to our standards: out.

And then there was the genuinely awful earnings and guidance from ReachLocal (RLOC), China Telecom (CHA) and Geeknet (GKNT). No mysteries there. Out. Gone. Vaya con Dios.

Overall, we sold 11 holdings during our February re-balancing, and bought 11 new positions to replace them: Broadridge Financial (BR), Mobile TeleSystems (MBT), Methode Electronics (MEI), Newport (NEWP), Insight Enterprises (NSIT), Netgear (NTGR), ON Semiconductor (ONNN), Raytheon (RTN), Super Micro Computer (SMCI), Stantec (STN) and TE Connectivity (TEL).

All of the new positions came from our quantitative screen that we ran on February 17. Plus we trimmed six winning positions that had grown too large, and added to four others that were too far below our standard 2% position size.

What about our own guidance? That's simple. In 2014 we plan to do what we've been doing since the year 2000: use our quantitative process to assemble a portfolio of companies we think will generate alpha. No change there.

February was a little disappointing for the Crabtree Technology portfolio. While market indices were higher across the board for the month, we lagged a bit. The Crabtree Technology portfolio rose 2.2% in the month, compared with a 4.6% gain for the Russell 2000 (RUT) benchmark and a 4.3% gain for the S&P 500 (SPX).

Our internal benchmark, the Merrill Lynch Technology 100 (MLO) rose 5.9% in February. The most widely held technology ETF, the Select Sector SPDR Technology (XLK) rose 4.4%.

Please see the Crabtree Technology model page on Covestor for a more complete picture of the portfolio's performance as well as important disclaimers.

DISCLAIMER: The investments discussed are held in client accounts as of February 28, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.

Barry Randall

Barry Randall

Crabtree Asset Management invests in growing technology companies. Barry Randall is the firm's founder and Chief Investment Officer. He has

Select the service that is right for you!

COMPARE ALL SERVICES
Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
DOW 16,931.81 +12.22 0.07%
S&P 500 1,981.40 -0.20 -0.01%
NASDAQ 4,519.3820 -8.1320 -0.18%

Brokerage Partners

Rates from Bankrate.com

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs