MEMC Electronic: Glass Half Empty or Half Full?

Jul. 25, 2008 5:42 AM ETSunEdison, Inc. (SUNE)14 Comments
R. J. Rhodes profile picture
R. J. Rhodes

With MEMC Electronic (WFR) getting hammered yesterday on disappointing earnings (see conference call transcript), investors are faced with the always difficult assessment of what to do with the stock. I make no claim to deep expertise on WFR, but here are some general comments on the quarter, the valuation and the stock market reaction.

Top line was about $10mm below the low end of management’s April 24th guidance. Operational issues were the cause. Some analysts are concerned because this is the 2nd quarter of such issues. Thus, the tendency is to extrapolate. But that is a human flaw. For a complex manufacturing process, operational problems are either indicative of poor process controls, or they are simply random events. Engineering types who follow the stock can perhaps answer this question. For now, let’s give the company the benefit of the doubt and call it random events, non-recurring glitches.

My red flags on the quarter would be: decline in gross margin yr/yr (but up sequentially), leading to modest negative operating leverage, and a slowdown in revenue growth. For growth investors, these are major issues.

In terms of the market reaction, it is useful to think about the sociology of the ownership. Pure quant funds will sell the stock today, no questions asked, owing to the negative surprise and slowing growth and negative estimate revisions and adverse stock reaction. Indeed, quant funds are successful because using the law of large numbers and disciplined decision rules, the batting average on success using these criteria is typically 55 to 65%, which is a significant statistical edge over pure random selection.

Some fundamental growth managers will also sell the stock today regardless of price, because they come to an unfavorable judgment about WFR’s future growth prospects. This is more of a qualitative decision, based on nuanced evaluation of a

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R. J. Rhodes profile picture
R. J. Rhodes is a private investor. Prior experience includes security analyst, director of research and portfolio manager at a major registered investment advisor before retiring in 2007. Investment style is eclectic, multicap and emphasis on cash flow valuation, strong balance sheet, growth or cyclical turnaround, and opportunity for a catalyst. Other than investing, current interests include reading investment books, gardening, cooking, photography, and maintaining 43 acre farm in North Carolina.

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