Not What You Expected

Take a Bow, Lady Gaga

There she was, onstage at the live television broadcast of the Academy Awards ceremony, belting out some tunes from The Sound of Music in tribute to the 50th anniversary of the film's release. I'll have to admit that I had never given much thought to Lady Gaga, except for thinking that she looked different every time I saw her, adorned as she always seemed to be in outrageous costumes, makeup and wigs. I never could figure out what she really looked like. I had also thought of her as more performer than singer, so when I heard that she would be performing at the Oscars, I figured that was my time to bring in some more firewood, check my emails, etc. Instead, my eyes were fixed on her. Not only is she indeed an exceptional singer, she was singing classic songs from a half-century ago. This amazing and riveting performance was not at all what I had expected. It was as if Justin Timberlake had stepped onstage to perform Rigoletto. Who knows, maybe that's next.

As investors, we are accustomed to developments that we did not expect, surprises of the pleasant variety and those of the most unpleasant kind. Fortunately for us, investing is one of the few endeavors where we can make a lot of mistakes and still be successful. That would not be true with, say, brain surgery. This happy state of affairs is made possible through diversification, and it allows for a portfolio to outperform the market even if it is holding a few duds. As for those duds--and the rock-star stocks, for that matter--what indication of company performance do we have other than the happy or unhappy tale that a stock's price movement might be telling us? That information comes in the form of quarterly earnings reports, and we are just now wrapping up the earnings season of reports on the quarter ended in December. As we have noted before, those earnings reports are similar to the report cards we used to get in school every six weeks. They tell us how our companies are doing--and, more important, they tell us how things are going relative to our expectations. Stock prices reflect a discounted valuation of what is expected to happen in the future, so if those quarterly reports indicate that sales and earnings are better than what we (Wall Street, actually) expected, and if the company's forward guidance tells us that these better-than-expected good times are likely to continue, the stock price should increase to incorporate this rosier outlook. That all gets thrown into reverse when the results fall short of our expectations.

Most of the stocks we follow here have had very good earnings reports, and we'll note a few highlights. First, let's define again what me mean by a "good" report. For our purposes here, that means that when it is showtime, the company reports a trifecta of earnings and sales that exceed the consensus Wall Street expectations, along with forward guidance that is also better than what was expected. Monster Beverage (MNST, $140) clocked in with results that lived up to the company's (and the beverage's) name, giving the stock price its own energizing jolt. Shares rose about 13% to a new 52-week high, and I counted no fewer than six investment firms raising their price targets on the stock. This is exactly what we like to see. A similar story played out with Home Depot (HD, $115), where it appears that all kinds of home-related goods have been flying off the shelves. Wall Street likes to focus on housing-related data such as building permits and housing starts, and that is certainly understandable, especially when it comes to assessing the prospects for the home builders. But HD may give us a broader picture of consumer discretionary spending trends as such spending relates to the home. As all homeowners know, you don't need to build a new house or move to another one when there's no place like your current money pit of a home for spending money. Those are the kind of expenditures that people can postpone, so it is another glimmer of encouragement for the economy that consumers are opening their wallets and purses to spruce up their environs.

Disney (DIS, $105) also exceeded expectations with its report, and shares moved up to  another new high. The company recently announced that it is raising the admission price for the Magic Kingdom to $105, which also happens to be where the stock is trading. Yep, one share of DIS stock will get you in to ride It's a Small World and watch the afternoon parade. Maybe they should just allow the admission price to fluctuate with the stock price--and then split the stock two-for-one just before we take our grand kids there someday. Parents also seem to be doing some spending at Carter's (CRI, $90), the retailer of clothes for babies and children, which also had across-the-board good news for investors. My wife and I have made our own contributions to the bottom line, as we love to see those grandchildren dressed to the nines. Visa (V, $273) and Mastercard (MA, $91) also joined the high-achievers party with their results, and we'll also note that Visa has now been crowned as the exclusive credit card for Costco (COST, $146), the warehouse club having announced recently that American Express (AXP, $81) would no longer enjoy that status. A company that may not have "household name" status is AmSurg (AMSG, $60), a Nashville-based owner and operator of ambulatory surgery centers. Last year AMSG acquired Sheridan Healthcare, a provide of outsourced physician services. Earnings came in at $.77 per share, ahead of the $.73 consensus estimate, with revenues also ahead at $581.8 million versus an expected $565.3 million. The company is relatively small, with a market capitalization of $2.9 billion, and may bear watching as a model of future healthcare delivery.

Big Losses at Weight Watchers  would have made for a clever headline, but the fact is that the company did not report losses, but instead earnings that matched the expectation of $.07 per share. It was, instead, the shortfall of revenues ($327.8 million versus a consensus expectation of $332.7 million) and a serving of disappointing guidance for the future that sent the shares tumbling more than 30%. Here we have yet another reminder that investing is all about the future. Earnings results are, by definition, a report card on the recent past. No matter how splendid that last quarter may have been, it is not going to help the stock price if the future does not hold similar promise. As for shares of Weight Watchers International (WTW, $10.50), the precipitous decline in the stock price suggests that the company's poor outlook came as a surprise to investors. Really? I think they should have seen it coming. The first shot across the company's bow came some years ago with the popularity of the Atkins Diet and its idea that you could eat all the bacon you wanted as long as you didn't put it on a croissant. The company seemed to recover from that, at least for a time, but let's note that the stock was trading around $80 per share just a few years ago and has been in pretty much free-fall since then. Despite the obvious fact that there is a huge (the pun potential is unlimited here, so my apologies) market for the company's services, there is also a growing plethora of ways to shed some pounds and get in shape, a number of which pose a challenge to established Weight Watchers orthodoxies. What the company does is not losing relevance, but how they do it may be.

Can positive financial surprises give us a tool for picking stocks?  Perhaps, as one of a number of factors we want to see in a prospective investment. The old "Cockroach Theory" holds that the lone cockroach we saw on the kitchen counter may have 100 cousins in the wall waiting for us to turn out the lights and go night-night. In similar fashion, a surprising earnings report might presage more of the same, in either direction. We don't want to be on the bad side of that, sleeping with the cockroaches. In my screening work, I will regularly screen for companies that have reported positive earnings surprises over the last few quarters--but that is only a start. It is worth noting also that a stock that doesn't move up on the heels of a trifecta report may be signaling trouble. That's part of the total picture: an exceptional earnings report, analysts increasing their future earnings estimates and price targets, and a stock price that follows accordingly. The real point today, though, is that we should pay attention to those reports as an assessment tool, just as we would give such attention to our child's report card.

Lady Gaga received a much-deserved, rousing, standing ovation for her mesmerizing performance at the Oscars. I would say that our trifecta stocks deserve a round of applause for their "Not What We Expected" performances, but I'd rather know that the hands of traders and investors were otherwise preoccupied placing buy orders.

Life is short. Get busy.

Jim

Disclosure/Disclaimer: My family members and/or I own shaes of MNST, HD, DIS, CRI, V, MA, COST, and AMSG. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.

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