Beware the Lady Gaga Effect on Growth or Rebound Stocks

by: Kurtis Hemmerling

Lady Gaga affecting stock market prices…how? Does this have something to do with her meat-outfit and the price of veal cutlets at the local superstore? The egg producing company Cal-Maine Foods, Inc. has not experienced much of a share price jump despite her bizarre Grammy appearance.

What is the Lady Gaga effect and how does it relate to buying and selling stocks?

The Lady Gaga Effect and the Stock Market

I do not listen to (or watch) Lady Gaga and I try not to follow the current music scene other than listening to the radio for a few minutes per week when I drive solo. That being said, I cannot deny that Lady Gaga is a household name with widespread media coverage. I have little doubt that much of her fame is due to her surprise tactics, use of shock, and extreme outlandishness. The problem with this type of extreme hype and awe is that people come to expect it. Each performance needs to blow away expectations built up by the last, and fans can quickly turn on someone that only delivers a performance that met anticipation, but did not exceed it.

High growth stocks with consistent and large earnings surprises may also suffer from unrealistic investor expectation. Take a look at Travelzoo Inc. (NASDAQ:TZOO) as one such example.

Travelzoo is Lady Gaga

Travelzoo is a high growth, internet-based travel portal. The last three quarters of earnings have been met with big upside surprises that shocked and awed.

  1. Mar 2010: 114.3% earnings surprise
  2. June 2010: 81.8% earnings surprise
  3. Sept 2010: 100% earnings surprise

All the while, the total earnings were jumping along nicely with total EPS growth 22.8% higher this year and 35% higher next year. But then the most recent quarter earnings report of December 2010 came along in an highly anticipated egg-like pod. When the final numbers came pouring out, they still beat average estimates by 15%, but expectations were not ‘blown away’. This was met by a massive price drop of over 20% in just a few short trading sessions.

When expectations run too high…watch out when they are not vastly exceeded. All it takes is for investors to start factoring in historical surprises into their estimates, and the stock will have little chance at all to blow away investors even with aggressive growth. (You might also be interested in the article about 'Strong Buy' Growth Stocks with Proven Track Records)

Other Stocks with Historically Large Earning Surprises

To find the list of stocks currently exceeding analyst expectations I used the following filters:

  • Previous EPS, last EPS, and average trailing 4 quarter EPS surprise > 50%
  • Nasdaq exchange
  • Trailing 12 month EPS > 25 cents

I wanted a history of big surprises on stocks with at least some earnings (not stocks without EPS that are simply not losing money as fast as expected).

Here is the list of stocks listed according to their average 4 quarter EPS surprise:

Ticker Name Avg. 4Q surprise% (4 quarters previous) Recent EPS surprise%
(NASDAQ:HUGH) Hughes Communications, Inc. 700 125
(NASDAQ:LION) Fidelity Southern Corporation 617 63
(NASDAQ:OSIR) Osiris Therapeutics, Inc. 336 250
(NASDAQ:PKOH) Park-Ohio Holdings Corp. 316 215
(NASDAQ:PROV) Provident Financial Holdings Inc. 299 105
(NASDAQ:IRBT) iRobot Corporation 244 85
(NASDAQ:COLB) Columbia Banking System Inc. 157 146
(NASDAQ:KELYA) Kelly Services, Inc. 94 69
(NASDAQ:CEDU) ChinaEdu Corporation 90 57
(NASDAQ:WSTL) Westell Technologies Inc. 85 75
(BEXP) Brigham Exploration Co. 72 67
(NASDAQ:GLDD) Great Lakes Dredge & Dock Corporation 61 160
(NASDAQ:PLPC) Preformed Line Products Co. 59 105
(NASDAQ:FTNT) Fortinet Inc. 58 82

Granted, some of these stocks are financial ones that could be merely bouncing back early from a very hawkish analyst expectation. These are not likely to suffer the same Lady Gaga effect as higher growth picks such as IRBT.

How to Trade the Lady Gaga Stocks
Does this mean we should sell stocks exceeding expectations? By no means! They could possibly make up some of the best growth or rebound stocks (Could these 18 stocks on the 52 week low list be ready to pop?).

You should, however, keep a very close eye on valuations and momentum. When too many investors buy with the expectation that next quarter will blow everyone's minds away, watch out for some short-term repercussions from people with poker faces.

Oddly enough, if the annual growth rates are high and expected earnings are still highly positive, this reset in valuations may actually create a better long-term holding entry point for growth investors. If short term sentiment batters a good stock, you should consider adding and counting your money (profits) instead of holding or folding them, walking away or running.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.