Tripling Your Money: Don't Get Shaken Out

| About: Pixelworks, Inc. (PXLW)

Editors' Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.

Thursday night, Pixelworks (NASDAQ:PXLW) reported its Q3 results. In after-hours trading, I believe that investor response was symptomatic of a common syndrome known as getting "shaken out". In this article, I'll discuss PXLW's earnings report and how getting shaken out can prevent you from tripling your money.

Starting with the shake out, it's important to understand that some investors employ a buy-and-hold strategy. Some go the opposite route and day trade. Still others choose to "play" earnings announcements. My personal belief is that the best method is to take a common sense approach. This is the safest way to avoid getting shaken out of a stock with a bright future.

When Wall Street professionals invest in a company, they develop a set of expectations for what management needs to achieve in order to justify their continued investment. These expectations have some leeway, because in real life, businesses don't move forward in a perfectly straight line. As long as the company remains on the path, I'm okay if they veer a little to the left (and of course, love it when they sway to the "right").

Before I started pre-establishing expectations, it was very easy to get shaken out of a position (scared into selling my stock). The shake down could occur because of something as insignificant as a few down days on the market. This is actually a typical human reaction to an uncomfortable situation, also known as fight or flight.

Deep in history, fleeing dangerous situations was prudent. On Wall Street though, fleeing what feels like a dangerous situation is foolish unless there is hard data to support the response. The after-hours response to Pixelworks' Q3 results serves as a perfect example of everything I have discussed to this point.

The company reported revenue of $15.3 million, which exceeded Street estimates by $0.3 million. Earnings of 10-cents per share were a penny shy of expectations, but an incredible improvement over Q2's 23-cent loss and the 2-cent gain reported for Q3 of 2012. Management's commentary in the press release and earnings call were both extremely bullish.

At first, the stock was bid up in after-hours trading, but eventually reversed course and slid as much as 15%. Why?

Without surveying everyone who sold their shares, it's impossible to know for sure, but here are a few thoughts:

  1. The selling occurred on very little volume -- small trades that wouldn't have as much of an impact during market hours.
  2. As mentioned above, some investors buy stocks ahead of earnings in hopes of an overnight pop (near-instant profits).
  3. Missing the one Wall Street analyst's number by a penny may have been seen as a miss. I disagree and see it as shortsighted, but understand the rationale.

To address the latter point, PXLW's management generally sets a realistic range of expectations. Sometimes they miss those expectations. Sometimes they exceed them. In this case, they performed well within the range of expectations they set on the Q2 call (which sent the shares soaring as much as 50% the next day).

Unfortunately, they choose not to play the Wall Street game of sandbagging expectations so they can "beat their numbers" each quarter. Despite my when-in-Rome belief that management should play the game, I also respect their right to set expectations any way they wish. The most important thing to me is that they're consistent, so I can judge them on an apples-to-apples basis.

Because they set a realistic range of expectations, I don't worry if they "miss" the Street estimates (which tend to sit toward the high end of management guidance) by a small degree. If $14-16 million is the goal, $15 million is a "make" in my book.

However, many investors think otherwise and will flee what appears to be a dangerous situation.

There's no imminent danger with PXLW, in my opinion. In fact, anyone who listened to the call heard a happy and confident management team discuss the progress they have made over the past several quarters and where that progress is leading them (something I have discussed many times in my PXLW reports on Seeking Alpha).

When I first discussed Pixelworks on May 31, I was promptly met with allegations of "pumping" the stock. To them, my assertion that PXLW might be chosen to power Apple's highly anticipated (though still elusive) TV set was irresponsible, if not criminal.

It didn't bother me. Most of my picks get greeted with the same response. It goes along with the territory. To find stocks that are poised to triple, it is often best to examine stocks that everyone hates (a topic for an upcoming discussion).

In fact, my best call of the year was greeted with hate mail.

I had claimed that Himax (NASDAQ:HIMX) would power Google Glass. It seemed like an outlandish statement to most. I can understand why. The Internet is littered with scam artists who will say anything to boost the price of a stock they own. Most investors aren't used to dealing with someone who is both honest and has the experiential background to discover seemingly incredible things before they happen.

At the risk of sounding cocky, I believe I meet both criteria. I've proven it consistently via my well-documented performance on Seeking Alpha.

Himax proved to be just another example. Four months after my initial report, Himax announced that my outlandish claim was indeed true -- it was going to be powering Google Glass. Investors who trusted in my analysis were treated to a stock that, despite several ups and downs, tripled in just seven months.

Those who were shaken out, for whatever reason along the way, missed out.

I continue to believe that Pixelworks could be next. As we reported last week, Pixelworks and Apple (NASDAQ:AAPL) will be appearing at same event in March. I'm not saying that a big announcement will come out of this event, but I wouldn't discount it either. Apple has been distancing itself from Samsung. They have already separated themselves from Samsung's displays and even formed a relationship to utilize sapphire instead of Corning's (NYSE:GLW) Gorilla Glass, something we anticipated as part of our investment in TechPrecision (OTCQB:TPCS).

Samsung possesses some of the industry's best video processing capabilities. If Apple is going to compete, it will need its own video processing IP. PXLW would make a perfect fit. Based on my extensive research, PXLW is one of the few remaining independent vendors (most went under during the Great Recession) and has garnered several wins for its market leading UltraHD processing technology.

Of equal importance, PXLW is adapting its technology to power mobile devices. On the Q3 earnings call, ROTH Capital Partners' Krishna Shankar asked management to discuss its chip development process for the tablet and mobility market. CEO Bruce Walicek responded:

"We're well down that path at this stage and we're anticipating demonstrations at a very deep technical level coming up at CES…we'd introduce products in the first half of 2014".

Perhaps this is why insiders haven't sold a share in years.

If investors think that a penny of EPS is more important than Mr. Walicek's last statement, I'll be more than happy to buy their shares as they get shaken out. Based on my pre-established expectations, I continue to believe that shares of Pixelworks are poised to triple.

Disclosure: I am long AAPL, HIMX, PXLW, OTCQB:TPCS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.