Q2 Earnings Preview (Part II): A Perfect Example Of What's To Come

Includes: BBY, HGG, KR, SNBR, SVU, TPX
by: Brian Nichols

<< Return to Part I

Yesterday I released my Q2 Earnings Preview, where I gave a bearish forecast for this upcoming earnings season, by saying that guidance will be weak and markets will be pushed lower over the next six weeks. For the last three quarters I have played earnings, which means I have purchased stocks either before or after earnings to capitalize on value. And with the exception of the most recent quarter the series has been a huge success. I have already said that I will release a weekly piece regarding earning picks for this quarter, but that for the first time it will be more about shorting stocks than actually buying for value due to an environment that prevents long investors from making any money while minimizing risks.

The key reason that I am not buying before earnings this season is because of the reactions following the companies that have already announced. I said yesterday that I don't expect earnings to be bad, but rather guidance to be conservative, thanks to a weak economic outlook and unemployment remaining too high. And in my opinion, the most dangerous reason that holding stocks are a bad idea (over the next two months) is because of the reaction to industries when one company lowers guidance. I gave one example of this reaction with hhgregg (NYSE:HGG) yesterday, but perhaps the perfect example was with Supervalu (NYSE:SVU) today, and the effect that its earnings had on the entire industry (rightfully so or not).

A couple months ago we saw as Tempur-Pedic (NYSE:TPX) lowered its guidance after it did not account for increased competition or a decline in demand at such a rapid rate. Once it lowered the guidance not only did its stock fall nearly 50%, but the stock of companies such as Select Comfort (SCSS) and the entire mattress space fell as well. Yesterday hhgregg lowered its guidance and announced preliminary sales results, and the same event occurred, Best Buy (NYSE:BBY) along with other electronic stores also fell, seeing as how the market believes weakness at one store must mean weakness across the board.

On Thursday, Supervalu created the same trend, which we have seen so many times and will continue to see throughout this quarter. The company suspended guidance, and announced that it will cut costs (including dividends) to focus on lowering its prices to become more competitive. Now Supervalu's bad news in no way affects other companies in the space, however following the announcement the entire grocery industry fell to a large degree. Despite the possibility that companies such as Kroger (NYSE:KR) may very well be stealing SVU's market share; the market assumed the worst and sold all stocks in the space, leaving investors to feel the pain.

Right now we are experiencing one of the most pessimistic economic environments since the recession and all it takes is one miss in the industry to wipe out 5-10% of other companies value. This creates a very dangerous investing environment; where if you buy a stock before earnings and it cuts guidance by 10% than your investment could decline by 40-50% (we have seen this many times during the last couple months). And if you are holding any particular stock long, and a competitor misses on its earnings, then you could wake up one morning having lost 5-10% of your investment, without any news from the company that you own.

At this time investors simply don't trust the market. No one feels secure enough to buy and hold any stocks, as retail investors are watching their holdings and are ready to sell on any movement. Ultimately, this could create a great deal of value, for companies such as Kroger, Best Buy, or Select Comfort if its earnings are strong. But rather than buying before earnings, or even after earnings, I strongly suggest to be patient and wait for this next two months to pass. With pessimistic reactions and a slew of economic uncertainties, buying before earnings is a huge gamble and one where your odds are much less favorable than playing a game of blackjack at your local casino.

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