After the close on Wednesday several technology firms reported earnings with vastly different stock reactions. In the tech world, earnings season tends to be a moment of wild swings. The stock reaction can be nothing more than expectations getting out of hand and investors turning too bearish or the result of a shift in the business fundamentals. Either way, the moves highlight the problems with investors getting too bullish or bearish as most stocks tend to eventually revert to the mean average.
In the after hours action, investors got a prime example of what happens when a market leader makes a move in one direction. The likelihood exists that the stock will revert to the mean eventually and no better time exists than an earnings report. This exact scenario occurred in the earnings reports for Akamai Technologies (AKAM), Equinix, Inc. (EQIX), and Fusion-io, Inc. (FIO) on Wednesday night.
Not that this always happens, but in this scenario the stock with the strongest gains over the last year plunged after hours while the weakest stock surged. Does this signal a change in the stocks or just a temporary rebalancing in the expectations?
Did The Last Year Results Predict The Stock Action?
Any investors watching the stock charts probably considered Equinix over extended and Fusion-io oversold. As the below chart shows, investors betting on a reversion to the mean likely made out this earnings season.
The internet content delivery leader soared in after hours trading after reporting a strong quarter due to increased traffic from media clients. Akamai earned $0.51 compared to analyst estimates for $0.46. The $0.05 beat came from revenue of $368M that easily surpassed the $358M estimate. Revenue increased 18% over last year's $319M.
The stock had been down for the year until it jumped in after hours providing the opportunity to turn green over the last year. The past technology icon showed that the weak stock action in the last year wasn't indicative of the future results.
The stock trades at only 16x forward earnings and may be a bargain now after a year of underperforming the market.
The stock fell substantially after the company reported weak results that missed analyst estimates. The data center operator missed earnings by $0.07 even though revenues were in-line. Equinix issued downside guidance for revenue of only $532M for Q2 that was easily below estimates calling for $543M.
The stock had soared over the last couple of years growing from nearly $80 back in September of 2011 to over $230 back in February. The stock had been up 46% in the last year alone.
Equinix traded at an incredible 43x forward earnings suggesting a reversion to the mean was needed to move the stock back in-line with the market.
The company easily surpassed the drastically reduced guidance after the last quarter. Fusion-io reported revenue of $87.7M and a small loss versus analyst estimates of $80M and a loss of $0.07. The real key is whether the long-term picture with new enterprise customers improved or if major buyers Apple (AAPL) and Facebook (FB) plan to initiate large quantity purchases again.
The stock was down substantially over the last year and even more dramatically since an October peak of $32. A previous article (see Double Bottom In Fusion-io?) speculated that investors might be able to buy the stock on the cheap with a potential double bottom, but the stock didn't hold and plunged all the way to $14. The after hours action though suggests that investors should've been aggressive at those levels with it trading above $18.
This convolution of earnings reports highlights the issue with momentum trading. Of the three stocks reviewed, the best performing stock over the last one and two year time periods had the worst report of the group. While Equinix still sports solid growth, the numbers aren't suggestive of a company that should continue trading at lofty multiples with a heavy debt load and high levels of capital spending requirements.
On the flip side, the worst performing stock was able to alleviate investor concerns over life without constant big orders from Apple and Facebook. Fusion-io is expected to bounce back with 34% revenue growth next year.
In reality, none of the three stocks reported revenues vastly different from analyst expectations though the numbers might have been better or worse than trader opinions. Forecasting yearly totals to hit $435M versus a previous estimate of $426 shouldn't impact the stock to the extent of double-digit gains.
If it really is a matter of stocks reverting to the mean average over time, than investors should consider a pairs trade of going long Fusion-io and shorting Equinix at these levels.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.