The Day Ahead: Channel Your Inner Financial Bushwhacker

This week was pretty weird. Did we get assorted earnings warnings and comments providing reassurance of zilch? Yes, but not on that next level of intense velocity I expected on Monday. Did the market struggle for decent enough chunks of individual sessions to make you go "huh?" while watching last minute buying? Yup, stocks appear to be pricing in this worldly philosophy: incremental improvement in key data components still entice the Fed to buy more debt we are unable to physically touch, and that could transmit quite effectively to the real economy should an apparent tax-slasher (Mitt Romney) gallop hard into the ribbon. Hey, it's no skin off my teeth who wins (maybe money from my mobile wallet), I am just picking the market's brain.

The market pendulum is swinging in the direction, once again, of the U.S. fundamentally rebounding from a summer swoon and being able to bolster sentiment amid a European Union situation that has hit its normal dormant zone. One day XYX is a focus point, the next it's ABC. It's all pure lunacy, which is why I am channeling my inner bushwhacker.

Bushwhacker: At a Glance

"While bushwhackers conducted a few well organized raids in which they burned cities, most of the attack involved ambushes of individuals or families in rural areas." -Wikipedia

To be a financial bushwhacker literally means to set fire to the day-to-day fluff inherent to the market and return to the foundation (some will call this fundamentals). Let's first give this a go with the September employment report.

Foundation

  • We know it will be below the magic number of 250,000.
  • We know it could sway the opinion of voters.
  • We know to ignore government inflation data and realize meager income growth is killing low-income households that enjoy consuming things.
  • The employment population ratio will continue to be a problem.
  • Global multinationals will continue to lay people off because they are global multinationals and because old ways of doing business are being proven outdated. For example, the Hewlett-Packard (HPQ) workers that will have the axe swing over their necks, where do they go as the "next gig" may not exist. It existed 10 years ago, not now. This is structural unemployment if I have ever seen it before.
  • Companies are unlikely to entertain any broad hiring decisions in front of tax and regulatory uncertainty, leaving the market to speculate that Fed Fairy Dust will do the trick sometime in 2013 -- because they will be spreading more of it than they divulged to us last month (Fed minutes signaled this, I fancy).

Maybe there are a few additional bullets to toss on the list, maybe not. I prefer to remain cautious on the market and within sectors, reflective of the fact my call horizon is longer than a day in most cases. The foundation of what we have witnessed from Wednesday on not only sports big cracks from a logic perspective, but an unimaginable number of terminates knowing at the planks further.

So how do we approach stock selection, you ask? Wonderful question. I have been researching potential third quarter earnings "horror stories" and then thinking about strategies to profit on the downside. One stock that fits this "horror story" qualification is Boston Beer ( SAM), and here is the thesis, boiled down.

Basics of a "Horror Story" Stock

Qualification #1: A company investing aggressively into 2012 end in marketing, headcount, or physical structures. This is happening while it's probable the Street has failed to adjust earnings estimates down to an appropriate baseline (modelers are watching the Fed, come on). Qualification #2: A company that has gotten in the face of Mr. Market to say earnings are at risk, but the market doesn't care today. Qualification #3: There is a disease in the financial statements that will worsen in the medium-term.

How Boston Beer Fills the Glass
  • Boston Beer has publicly stated that it is "prepared to forsake earnings in the short-term" to invest. Yet, the stock trades at 25x forward earnings (beyond exorbitant multiple for a packaged food company or a consumer staple, you choose), building in a takeover rumor in the valuation that has been around for as long as I have covered the company (Qualifications #1 and #2).
  • The heart of the business, Sam Adams non-seasonal brews, is experiencing waning volume (Qualification #3).
  • The gross margin is being eaten by higher costs and unfavorable product mix (Qualification #3).

At the time of publication, Sozzi had no positions in the stocks mentioned.

Brian Sozzi is Chief Equities Analyst for NBG Productions. In this capacity, he is responsible for developing independent financial content and actionable stock recommendations (including ratings and price targets) for an institutional and retail investor base. In addition, Sozzi is the Editor in Chief of the "Decoding Wall St." investor education online platform.

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