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.
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).
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.
The post When Bad Guidance is Good News appeared first on Smarter Investing
Covestor Ltd. is a registered investment advisor. Covestor licenses investment strategies from its Model Managers to establish investment models. The commentary here is provided as general and impersonal information and should not be construed as recommendations or advice. Information from Model Managers and third-party sources deemed to be reliable but not guaranteed. Past performance is no guarantee of future results. Transaction histories for Covestor models available upon request. Additional important disclosures available at http://site.covestor.com/help/disclosures. For information about Covestor and its services, go to http://covestor.com or contact Covestor Client Services at (866) 825-3005, x703.
Check Out Our Best Services for Investors
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Model portfolio
- Stocks trading below $10
- Intraday trade alerts