Is This Sympathy Sell-Off a Buying Opportunity?

Brendan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

So What Is a Sympathy Sell-Off?

A sympathy sell-off occurs when investors in one company react to another company’s bad news. If two companies manufacture widgets and company A reports a weak quarter investors may sell company B anticipating earnings will be weaker than expected. The sell-off may be a buying opportunity when fears are unfounded or already discounted.  Perhaps, company B makes better widgets and the poor results of company A are the result of a loss in market share.

Alternatively, company B may have already been priced for a slow-down in orders. The sell-off may then be over-discounting a real problem, but investors could be more bearish than is warranted. Clearly the first case is the best buying opportunity, but the second may offer a good chance to pick some shares up on the cheap if you are constructive on the the company long-term. 

Ok, Makes Sense: But What's On Sale Today?

Last Friday Accenture (NYSE: ACN) delivered profit that exceeded Wall Street’s expectations at $1.14 per share versus $1.03 for the previous year. However, the company came up short on the top-line with revenues declining 5.8% year-over-year from $7.42 billion to $7.20 billion. Accenture's shares were hit quite hard on the disappointing news, declining by over 10% to $72 per share.

Due to Accenture's results, shares of several companies in the same sub-industry declined in sympathy. Accenture is a global leader in information technology and consulting with operations in 54 countries serving 19 industry groups. While the IT and consulting sub-industry performed quite well in 2010 and 2011, more recently levels of caution have risen for discretionary spending among businesses, particularly in Europe. Let’s examine a few competitors that sold off and see if they represent buying opportunities.

Cognizant Technology Solutions (NASDAQ: CTSH) declined only 0.73% in sympathy, but had already declined 15.2% YTD. Cognizant serves the IT sector offering outsourcing services with the majority of its oversees workers in India. The company’s shares have experienced disappointing returns due to a decline in revenue growth, which has slowed from an average of 28% over the past five years to an expected rate of 17% going forward. Cognizant is attractively priced and outsourcing should still garner demand even in a weak environment as businesses seek to control costs.

The challenging aspect of investing in Cognizant is that buying shares in a hyper-growth company after growth has slowed can be very frustrating. Since May of 2011 the TTM P/E of the company has compressed from 33.75 to under 18. If growth continues to slow, price appreciation may be difficult for several additional years and Cognizant may continue to lag the market. The company is a good name to watch, however, I would wait to buy until revenue growth has stabilized.

International Business Machines (NYSE: IBM) declined by 2.3% in sympathy sending shares back to roughly where they were at the beginning of the year. IBM operates in several segments including: global technology services (38.7% of revenues), global business services (17.9%), software (24.5%), systems and technology (17.0%) and global financing (1.9%). The current selling in IBM is likely a buying opportunity because the market had previously discounted nearly identical results.

In mid-April IBM reported earnings that were very similar to Accenture, with earnings missing slightly at $3 per share, while revenue fell 5% from one year earlier. While this might seem familiar to you, the market apparently has a very short memory and promptly sent IBM shares lower for a second time.  However, if IBM’s disappointing results were already discounted, what difference does the Accenture report make? Furthermore, because the price of IBM already recovered after its own disappointing report, it seems very likely that it will be able to recover from a competitors disappointing report.

It should be mentioned that some patience might be required before a turnaround occurs. I do not dispute that IBM suffers from the same headwinds as Accenture, however, the market may now be over-discounting fears of a slow down now could be the time to buy. The valuation of IBM is compelling at 13 times trailing earnings, or a PEG ratio of 1.36.

While revenue growth has been sluggish, the company has returned cash to shareholders at a remarkable rate and is set to repurchase $50 billion of stock over the next five years. At this rate half of earnings growth is the result of repurchases (5% per year), while margin expansion has continued to fuel EPS growth. For IBM shares to catch fire revenue growth must reassert itself, however, in the era of big-data this seems to be an eventual certainty.

SAP (NYSE: SAP) declined 3.7% on Friday and is now down 9.4% YTD. SAP is a German-based company and the leading provider of enterprise application software used for budgeting and accounting. SAP has done well growing revenue at a 7.5% annualized rate, however, earnings growth has lagged indicating that margins have contracted over the past five years. At 23 times TTM earnings and a PEG ratio of 2.08, SAP does not seem attractively priced in light of the difficult operating environment for the sub-industry. As a result, I would need to see lower prices before putting money to work in the name.

The Bottom Line

Sympathy sell-offs are the greatest opportunities when investors fear that two companies will have equivalent results and jump the gun selling shares at a bargain price when little danger actually exists. As noted above, this is probably not the case here because the companies discussed above have growth headwinds.  However, because the market is punishing IBM twice: first for its own earnings report and again based on Accenture’s results, it seems likely that investors may now be overly bearish and the stock should perform well over the short and long-term.  Big Blue may be black and blue, but that should not scare long-term investors away from an attractive buying opportunity.

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Brendan O'Boyle is long IBM. The Motley Fool recommends Accenture. The Motley Fool owns shares of International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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