Covestor's  Instablog

Today let’s look at two bearish additions in the form of a short sale and an ETF.

In his Mark Holder takes advantage of opportunities he sees in the market. This includes investing in sectors that have been beaten down. This week, Holder sold short shares of Amazon.com Inc (NASDAQ:AMZN). With a high price to earnings ratio, the e-reader price and development war heating up and Amazon coming under fire for releasing questionable statistics regarding its e-book sales, it will be interesting to see if Amazon’s stock price drops in the coming weeks. Amazon’s stock price shot up from a closing price of $93.45 on October 22nd, 2009 to a closing price of $118.49 on October 23rd, 2009 after they announced a 69% increase in profits for the third quarter of 2009. Since then their stock has drifted from a low closing price of $108.61 on June 29th, 2010 to a high closing price of $150.09 on April 22nd, 2010. 

Next, Covestor model manager Top Stocks for the Week bought ProShares UltraShort Financials ETF (SKF) for their Top Internationals model. In this model, the manager invests in international top performing companies with impressive earnings and sales growth, low debt-to-equity ratios and strong balance sheets. SKF is an ETF that attempts to perform at 200% of the inverse of the Dow Jones U.S. Financials index, which has never recovered its 2007 highs. As of the date of this post, the fund is trading just below NAV.

Let’s take a look at two positions added by our Covestor model managers this week. One manager looks beyond creative accounting for his model while the other uses a rotational approach to investing in sectors and market indices.

We’ve talked about Sean Hannon’s Bottom-Up Analysis portfolio before and mentioned its goal to look beyond creative accounting and take advantage of market inefficiencies. This week, Hannon added shares of eBay Inc (NASDAQ:EBAY) to his model. eBay’s increasing net revenues, stockholder equity, earnings per share and net income certainly speak to the power of online selling. In addition, their unique position in the world of online auctions gives them an almost unrivaled presence within the booming sector. Their stock price dropped recently after they adjusted their projected earnings per share down for the year, but their revenues and earnings are showing signs of growth and are beating analyst’s expectations.

Model manager Amin Khakiani manages the Quantitative Hedging model. This model invests in different sectors and market indices. Since many sectors offer cyclical profit cycles, Khakiani’s model uses a rotational approach allowing him to take advantage of these cycles. This week Khakinani added RF Micro Devices Inc (NASDAQ:RFMD) to the portfolio. RFMD designs and manufactures the semiconductor components used in your wireless devices, wireless local area networks (WLAN) and in the defense market. The company has a low price to earnings ratio compared to competitors and increased earnings per share and stockholder equity in 2009. While the electronic technology is considered a cyclical sector, consumer trends in purchasing technology don’t seem very cyclical at all.

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Disclaimer: The Covestor Earnings Surprise model owns ETM, SLAB, VECO)

The earnings surprise pattern in fundamental data has a history. Over the past 15 years since filings began to appear on the Internet, we have observed many thousands of surprise patterns both positive and negative.

The positive earnings surprise pattern locates an accelerating company. Higher sales growth and rising gross margin on the top line can produce a surprise. Lower SG&A expenses to sales and lower interest costs produce leverage to accelerate the bottom line, thereby also producing a surprise.

Positive and rising cash flow return insures that the company is making money and that cash flow profitability is rising.

Because the pattern repeats we can measure its effectiveness in isolating good buy decisions.

Entercom Communications Corp. (ETM) will report their 2q2010 earnings on July 26, 2010. The shares are in the Earnings Surprise model and have been the worst performer so far. The company fundamentals produced a positive surprise pattern in 1Q2010 for the first time since 2000. Sales growth was up in 1Q2010 but remains negative after falling to a low point in 2009. The gross profit margin is up and SG&A costs are unusually high. This is an important factor. The share price of ETM has been extremely inversely correlated with SG&A to sales over the 11-year record of the company.

The cash flow profitability of the company is low but has been rising during 1Q2010 and 2Q2010. The free cash flow margin, which has been rising since 3Q2009, has been largely correlated with the share price with a one-quarter lead.

ETM has been a volatile stock, but I expect a positive surprise anticipated for July 26, 2010.

The companies with positive earnings surprise patterns and depressed share prices that will report earnings on July 26, 2010 are: Coach Inc. (COH), Entercom Communications Corp. (ETM),FARO Technologies Inc. (FARO), LeapFrog Enterprises Inc. (LF), Masco Corporation (MAS), M/I Homes, Inc. (MHO), Sanmina-SCI Corp. (SANM), Stone Energy Corp. (SGY), Silicon Laboratories, Inc. (SLAB) and Veeco Instruments Inc. (VECO).

Silicon Laboratories, Inc. (SLAB) and Veeco Instruments Inc. (VECO) are in the Earnings Surprise Model portfolio. I will review the financial statements of all the companies in the Earnings Surprise Model portfolio as the filing becomes available.

Alcoa, Inc. (AA) is in the Earnings Surprise model portfolio and produced their 10-q filing for the 2q2010 on July 22, 2010 (www.google.com/finance?q=NYSE:AA&fst...). The earnings announcement was July 12. The company fundamentals continue to trace out a positive surprise pattern after the 2q2010 update. Sales growth continues a ‘v’ shaped recovery but still remains negative as the company continues to recover from the worst downturn in its record. At the last cycle trough in 2002 sales growth reached a low and was positive after four quarters of improvement. The last cycle low in sales growth was four quarters ago in 2q2009. The most recent annual sales growth rate is a big improvement but still a disappointment. I would prefer sales growth positive. All of the components of a positive surprise pattern remain in place after the 2q2010 update. The cash flow profitability of the company is low in the record but continues to improve. The factor has been largely correlated with the share price with a one-quarter lead. The shares have not performed well and remain depressed. The stock will remain in the Earnings Surprise Model portfolio.