Can We Get Back to Stock Picking Now?

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 (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 (STJ) 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 (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 (RLI) beat estimates by $.28 with a $1.32 EPS showing. Shares were up over 4% after hours.

And finally, toy maker Hasbro, Inc. (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.

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

Comments

[Pj568:]

Wondering why a decrease of 28M in operating earnings is considered a "strong quarter"? Their increase in actual earnings was due to less "other inc/exp" recorded of 82M. On a GAAP basis they did make 10 cents which was up from 7 cents.

Writers don't even know what earnings are being adjusted for and don't care if its proper or not. The 20 cents/share referred to is due to BSX adding back 7 cents of standard amortization exp. The next step could be to start reporting EBITDA and forget GAAP altogether.

Jul 22 07:07 AM

[Ryan Barnes:]

hey PJ, you'll excuse me if I object to your comments. I've been covering BSX for over five years and been published on them quite often. For a company like BSX that has been in the doldrums ever since the GDT train wreck, yes, it was a good quarter.

The $28 million drop you mention was spread out over higher R&D ($10m), IP asset impairment charges ($10m), and also higher SG&A...now the latter could have been reigned in better, but you had better be careful when you say something like "writers don't even know what earnings are being adjusted for"...

Are you suggesting that the $85 one-time charge recorded in the year-ago was part of an elaborate sandbag? That they recorded it just so 365 days later they'd have easier comparisons?

And sure, let's just get rid of GAAP and start using EBITDA instead....oh, you don't mind if the S&P 500 firms add $13 trillion in debt to their balance sheets next quarter, do you? Jeesh...

I appreciate your vigor for the nitty-gritty numbers on this particular company, but there's simply not enough space here to spout off the entire financial statement for each company mentioned. That's what the transcripts and SEC filings are for.

All that said, I have no problem admitting when I'm wrong, and my hopes for STJ to turn in a good quarter have been largely dashed. It looks like the company wasn't able to execute the same level of market share gains as in past quarters. Companies that have held to full-year guidance all year seem to be treated a little too harshly in this market. Que Sera, Sera

Best of luck in your investing efforts.

Jul 22 09:55 AM

[Pj568:]

Ryan,

"And sure, let's just get rid of GAAP and start using EBITDA instead"

You missed my sarcasm. BSX is already half way there as they adjust earnings for standard amortization.

Jul 22 11:04 AM