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Don't Invest Based On S&P Ratings

|Includes:AMD, DELL, HPQ, MSFT, Sirius XM Holdings Inc. (SIRI)

The U.S. credit outlook is now "stable" according to S&P, but investors hardly batted an eye when the news came out Monday. "Few investors care what large rating companies say about the debt of developed countries these days," says the WSJ. And why should we? We already knew that the DJIA recently hit a new high and that cyclical stocks are up. S&P's rating change didn't tell us anything new about the U.S. economy.

As it turns out, S&P rating changes aren't very informative when it comes to corporations, either.

Show me the numbers

Take Sirius XM Radio (NASDAQ: SIRI), for example. Remember its 2009 troubles? Since then, the company managed to avoid bankruptcy and begin a dramatic recovery. Check out how steadily these numbers improved over the last three years.

Category

2010

2011

2012

Revenue

2,817

3,015

3,402

Net Income

43

427

3,473

Debt Ratio

97.20%

90.60%

55.40%

Click to enlarge

(data from Morningstar, revenue and net income numbers in millions)

Higher revenue and net income figures show successful company operations. The declining debt ratio tells us about the company's improving financial health. In 2011, investors could already see that the company was recovering. So when S&P raised Sirius's credit rating to BB in late October 2011, investors didn't get excited. Actually, the stock price dropped 10% over the next four days of trading and didn't bounce back up for nearly a month.

What real price changes look like

There was no investor response to speak of when Advanced Micro Devices (NYSE: AMD) received a lower S&P credit rating. S&P handed AMD a B rating on January 8 of this year. Here's AMD's stock price from January to June of this year. Look at January's price level first.

(click to enlarge)

Chart from Morningstar

The price hardly changed for months after S&P's announcement in early January. Now look at late April. Something switched investors' expectations, and it wasn't a ratings change.

That was Microsoft's (NASDAQ: MSFT) announcement of the Xbox One, equipped with AMD processing chips. AMD's stock price leaped 66% in three weeks! Microsoft's gains started the week before with a strong Q3 earnings report. Investors responded positively and the Xbox One news propelled the trend higher - a 17% climb for Microsoft shares in only 2 ½ weeks.

News that matters

Two more cases illustrating my point: HP (NYSE: HPQ) and Dell (NASDAQ: DELL). When S&P dropped HP to a BBB+ rating on November 30, 2011, the stock price slid 10% from $28 to $25 in under three weeks. But the bad news was still to come. What happened next made the first response look mild. In February, the company reported a 44% decrease in Q1 2012 net income. That was what investors really didn't want to hear. HP's stock price fell 20% in a month. And it kept falling as troubles multiplied throughout 2012. HP shares finally bottomed out at $11.64 in November of last year.

Dell's investors lost some confidence when takeover prospects disappeared in late April 2013. A disappointing Q1 earnings release on May 16 didn't help, either. By the time S&P lowered Dell's credit rating to BBB on May 20, Dell's struggles were old news to investors.

The S&P is late to the party

S&P credit ratings matter to creditors, not to shareholders. What shareholders really care about is news like M&A announcements, new product releases, and quarterly earnings reports. A credit rating change simply confirms what investors already know. So do your fundamentals research and follow company headlines to discover trends. Don't wait for S&P to tell you the trends already happened.

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

Stocks: SIRI, HPQ, DELL, MSFT, AMD