2 Case Studies In Taking Advantage Of Wall Street's Earnings Estimate Game

| About: Tempur Sealy (TPX)
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Now everyone loves that period of the year that happens four times annually. Quarterly earnings releases.

So, let's say your company grew revenue and earnings by 3% YOY (year-over-year). Isn't that great? Yes, it is. Especially if your company has shown it can increase earnings consistently over time.

But Wall Street doesn't want you to think that. They projected 3.5% revenue and earnings growth, so this company is not one of the high-fliers that you should be buying because it "missed estimates." Instead, they tell you to sell, and that's when you see prices crash the day of earnings by more than 10% on occasion, only to return to previous levels when the market's mania subsides.

After some thought, I'm convinced that earnings estimates are another way for Wall Street firms to increase trading by introducing "negative" news into the market place, even when there is none.

To be sure, missing estimates is not a great thing since management usually guides analysts toward those estimates. But what drives stock price? Earnings. So if a company is regularly and consistently increasing its EPS, price appreciation should follow.

It makes no sense to me how companies can lose 10-20% or more of their market cap in a few days over missed estimates, especially if it is not a high P/E stock. Very smart 22-25 year old analysts (like me, but probably significantly more intelligent) come up with these earnings estimates, so I can't take too much stock in their understanding of the business or how it should be valued.

After that rant, let's look at two companies that have experienced what I just described.

First, Gentex (NASDAQ:GNTX). GNTX is the leading global maker of auto-dimming mirrors, with 88% of that market. Its products are shipped around the globe with 44% to Europe, 23% to Detroit, 19% to Asia-Pacific, and 13% N.A. transplants. Based on Morningstar info, GNTX has grown revenue and EPS an average of 12% and 10% over the last 10 years, with one down year, 2008. Earnings declined 48% that year, by the way, but grew 108% in 2010.

So, the story with Gentex is the company reported earnings recently on July 24th. The company missed consensus estimates of 0.29, with earnings of 0.28. Revenue grew a measly 15%, to boot.

What did the stock do? It closed 7/23 at $21.14, and closed 7/24 at $15.00, a 29% loss in one day. Since then, the stock has gained 23% and is currently trading at $18.72. This is a solid company with a technological competitive advantage and a great dividend as a cherry on top, but there was a short-term opportunity to purchase the stock, which frankly probably still exists.

Second, Tempur-Pedic (NYSE:TPX). Tempur-Pedic is the leading global manufacturer of premium mattresses and pillows, and it reported earnings July 24th. Unlike GNTX, TPX did report decreased quarterly earnings 40% lower YOY, which prolonged a fall dating to TPX's guidance announcement April 20th. The stock fell from ~$80 in late April to ~$20 in late June, just two months. This loss was due to management guiding earnings lower for the full year and second quarter.

The question we as investors have to ask ourselves is were the declines in GNTX and TPX warranted, and was the market irrational in valuing these leading businesses at less than 70% of their original market cap in short periods of time?

If the market acted irrationally for a spell, then these types of scenarios may provide ample opportunity for investors to jump in and add to current positions at attractive valuations.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in GNTX, TPX over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.