I recently wrote an article about Pandora (NYSE:P) (click here to read) after earnings that didn't paint a very pretty picture for shareholders. It's a repeat of an event I have seen play out hundreds of times over the years. Once you have traded or at least watched enough earnings results you start to pick up on patters that can be quite profitable or at the least can provide comfort in knowing what to expect. One of the repeating patterns is companies in "growth mode" missing on guidance tend to get crushed. Of course the amount of the crush is directly related to the amount of the miss based on expectations (not estimates).
We can also see the same reaction with Hewlett Packard (NYSE:HPQ) at the end of last month. Meg Whitman cannot be held responsible for the earnings HP had, but she inspired little confidence with forward guidance and the stock once again was hammered. HP is currently trading around $24.35 and I rate it a strong buy, but I also own in for the long term as a core holding which I will get back to in a minute.
Fellow Contributor Rocco Pendola happened to also write an article about Pandora and even though we communicate often at times, we wrote our articles independently of each other with quite the opposite conclusion based on a different point of view. For Rocco the earnings call was as near of a non-event as an earnings call can be. When Rocco bought Pendora he didn't buy the stock symbol "P" he bought the company "Pandora" as a long term investment based on a changing environment and emotional issues with short term gains or losses in the company which isn't a factor in the long term plan. You can read his reasons for his position here.
Rocco also writes an options newsletter in which I contribute dividend capture ideas and my picks of the week. The newsletter comes out on Tuesdays. It's no surprise the newsletter is growing daily in membership and gathering as much positive feedback as it received because Rocco clearly puts a lot of work as well as his heart into the project.
Always on top of things, Rocco sent me a text asking what my subject was for next week's newsletter. With my typical jokester smart alec way of avoiding the question I answered "why I should sell Pandora but won't." At first glance it may appear offensive to make jokes about someone else's position when it's moving against them. The luxury you have when someone is there to congratulate you as well as "beat you up" is it keeps you grounded and modest. It's easy to find people to congratulate you when you're at this very moment in time making what appears to be good stock calls. Apple (NASDAQ:AAPL) currently is minting brand new stock market "geniuses" right now with every tick it moves higher. I say it with tongue in cheek because with every bull market and with every raging bull stock, there are investors and traders confusing a bull market with brains. Having someone like Rocco to remind me about holding on to Research In Motion (RIMM) helps to keep me grounded and centered on what I am doing.
Is this a case of my prediction being correct and Rocco being wrong about Pandora? No. The message that needs to be taken is having a written plan is what keeps your investing "investing" and not gambling. For me, my plan if I was going to put on a position with Pandora it would have been a short fade into the bounce on the third and fourth day and again yesterday when the price broke support. That would be the correct position for me based on my rules.
For Rocco, his position rules are not based on short term price movements, but rather the direction of the company. The numbers didn't come in as expected, but this was not a cause of alarm or even worry because the direction the company is headed in has not changed. The market space and potential for Pandora has not changed and so the current price has very little meaning in terms of acting in the role of a long term investor. If Rocco did not have an investment plan, it may be easy for his emotions to get the best of him and start to question what he is doing, especially in the face of another calling into question if he should be in the position. Had Pandora killed the earnings release and the stock moved to $25, Rocco would still not have sold the shares because once again, it was not part of the plan to make a quick buck.
Having a written plan is what is needed if you want to beat the averages and truly take a professional approach to capital allocation. Having a written plan also helps avoid the natural response when an investment doesn't work out. Called "risk aversion" the concept is people naturally will want to hang on to losers for too long and winners for not long enough. We all have done it or know others who have held a winner and watched it turn into a loser only to sell at the very moment we could "break even." Those types of responses to price action are the typical risk aversion moves of someone without a plan.
Moving back to Hewlett Packard, my normal short term plan calls for dumping any stocks that fall X% regardless of the reason. For me the price drop is the reason to exit and I give it little thought because I know investing is not about an idea working out or not. It's about a concept and portfolio working out and a portfolio cannot work out if part of it is dragging down the rest due to an inability to cut losses short. Like Rocco with Pandora I did not buy HP in hopes that the stock would jump and I could sell. I bought HP because I wanted a core technology holding paying dividends and I would write options against. If HP rose, I may have to buy a call option back at a higher price to maintain the position, but I am comfortable with that knowing over time the premiums gathered should be greater than paid out.
RIM is another stock that I am holding with a plan that doesn't have a very large price component. I wrote several bearish articles, but have since written several bullish articles based on the current market situation being fully priced in and above. I believe RIM is worth at least 12.75ish even if dead so buying in the current environment makes perfect sense. I also have written covered calls and will continue to do so.
I believe buying RIM under $15 and selling weekly covered calls for a current price of around $0.14 is an excellent hedge while still allowing for considerable upside. It is excellent for me, but may be the wrong choice for you. The way to know is if it follows your trading plan. If you don't have a written trading plan you may want to take some time to write one up. Allowing emotion to influence you may be the right thing to do on any one given position, but over time and over the years, the odds are against you to make as much money as you will with a written plan.
Rocco knows this and so do I and that is why we can have different opinions about the same stock and both still are doing the correct thing. We follow our plans to make money, not to build self-esteem. And taking a loss doesn't have to mean we were "wrong," it simply means we put ourselves into a position to have an edge and it didn't work out. We both know that if we invest with a plan using an edge we will make money in the long run. After all, you are investing to make money right?
Final note, as I write this on a Friday Morning I am watching Pandora as a covered call trade for a weekend bounce higher on Monday.
I use a proprietary blend of technical analysis, financial crowd behavior and fundamentals in my short-term trades, and while not totally the same in longer swing trades to investments, the concepts used are similar. You may want to use this article as a starting point of your own research with your financial planner.
Disclosure: I am long HPQ.
Additional disclosure: May initiate a long with P.