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If Q2 Earnings Continue This Trend, We Can Finally Get Back to Stock-Picking

Posted on | July 20, 2009 Time: 11:52 pm |

As second quarter earnings roll on, an amazingly high percentage of companies are soundly beating estimates - over 70% thus far. To the eternal pessimists out there, it’s no real harbinger because estimates were set embarrassingly low. However we’re not just seeing minor beats, but an increasing number of major beats - beating estimates by 20%, 30%, or more.

Most of this has come from major improvements to gross & net margins, as companies are working harder than ever to wring efficiencies out of their business models. Yes, we all know that revenues are down year-over-year in nearly every industry. But if companies can turn in a fundamentally impressive (albeit lean) quarter, we can go a long way to bringing back the essential art of fundamental investing, which has been on a forced sabbatical for several quarters.

And trust me, that’s vital even if fundamental investing ain’t your brand of whiskey when it comes to picking stocks. Because somewhere between “a lot” and the $3.5 trillion in cash & riskless return funds sees no other way to invest, and that money has been laying in wait until it sees some concrete signs that it’s o.k. to get back to the business of evaluating companies on their metrics and merits.

Raging Capitalist Hormones…It’s a Good Thing

As I mentioned in an earlier post, we should be thankful that capitalist instincts are raging like teenage hormones again. And not in the sneaky “climb out the window to party” way of debt-laden acquisitions or off-balance sheet shenanigans, but rather the old-school methods of being miserly about costs, internal processes, and marketing practices that never provided the bang for the buck that was advertised on the label.

It’s becoming all too clear that most companies need a good smack in the face every decade or so to remind them of how important it is to look at the business from the ground up, and make the hard choices when needed. In another nod to the sour faces in the crowd, I understand that many of these cost cuts have been the elimination of jobs and the shutting of factories.

It’s sad to be sure, but labor has been - and always will be - a large and variable cost of doing business. But instead of lamenting any minor sliver of success on the corporate front, how about we all take some joy in the reality that nobody is going to hire again until they’re sure they can make money TODAY. From my modest perch, more and more companies are proving to us - and themselves most importantly - that they can fight their way back to the black.

Earnings Highlights, July 20th…After Hours Screens Go Green

Boston Scientific (NYSE: BSX)  turned in a strong quarter late Monday, cruising past estimates for $.14 earnings per share with a $.20 showing (ex-one time items), while also hitting the upper range of revenue estimates. Shares were up 6% in after-hours trading. Thankfully for BSX, bad hearts seem to be a bankable secular trend for the next decade. On the back of BSX’s 5.3% rise in sales of pacemakers and related ICD’s, I see St. Jude Medical turning in a very rosy quarter on Thursday, given their recent market share gains. (BSX was recently added to the Secular Trends Portfolio)

Enterprise software producer JDA Software (JDAS) stormed past estimates with adjusted EPS of $.47 vs estimates for $.31 on a 77% rise in software licensing fees. Total revenue was up just 8%, but up is up folks, and the top line beat estimates by nearly 15%. Shares were rose over 20% after hours.

Asset Manager Legg Mason (NYSE: LM) managed to reverse a year-earlier loss with EPS of $.35 despite still seeing net fund outflows, thanks to a 32% drop in operating costs. Shares were up over 5% in post-session trading.

Midwest property/casualty insurer RLI Corp (NYSE: RLI) beat estimates by $.28 with a $1.32 EPS showing. Shares were up over 4% after hours.

And finally, toy maker Hasbro, Inc. (NYSE: HAS) posted $.32 EPS vs estimates for $.23 on the back of strong sales for merchandise related to Transformers 2 (ed. note: I remain shocked that anyone has seen this movie); shares were up over 4% in Monday’s regular session.

Parting Thoughts

At the end of the day, we still need revenues to come back, and yet must also accept that for many industries there will indeed be a “new normal” baseline level. But a big part of business - just like life - is about building the virtuous cycle. And getting lean, turning a modest profit, is without a doubt the first step. It builds confidence, and confidence builds jobs.

Not every company will wow us. And that’s exactly how it should be. The whole point of “survival of the fittest” is that some folks don’t survive. But companies with stellar management and strong balance sheets have chances to improve themselves a full order of magnitude higher than the “also-rans” out there. And that’s just what the stock-pickers of the world thrive on - ’cause we know how to find the pace-setters.

Ryan Barnes

disclosure: author does not hold personal stakes in the companies mentioned. STJ is held in the Secular Trends Model Portfolio

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