Illogical Trends on Thursday Might Create Value ... or Value Traps

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Earnings create movement and set the trend for a stock for the following three months. A stock can post a blowout quarter and see great movement and a shift from pessimism to optimism (i.e. Netflix) or vise versa. But sometimes, the market gets it wrong and the stock trends in an incorrect direction. Sometimes it creates value and other times it creates a value trap. With that being said, let’s look at the three most obvious cases on Thursday

Large Pharma Growth is Tough to Come By

We’ve seen several notable trends for this earnings season, and one has been declining revenues and profits for large pharma. The reason has been due to the patent cliff that these companies are enduring, therefore when I saw that Amgen (NASDAQ: AMGN) grew by 11% I was very optimistic. The company saw more than 100% revenue growth from its drug Xgeva, to prevent bone injuries in cancer patients, and also 100% growth for Prolia, for osteoporosis. Furthermore, the company increased its EPS guidance, reiterated bullish revenue and CAPEX guidance, and guided for $1 billion in sales in emerging markets.

Despite these strengths, Amgen fell over 1.5% after reporting earnings. The company did miss bottom line expectations, but only by $0.04 and mostly because of acquisition related costs. The stock had been sitting near all-time highs but was not expensive; it traded with a P/E ratio of just 15.50 and a price/sales under 4.0. Therefore, I see no reason for the decline, and believe the pullback could be a great opportunity.

Impressive Performance for an Unimpressive Quarter

Shares of transportation company Con-way (NYSE: CNW) traded higher by over 7% after posting mixed Q4 results. The company beat revenue expectations by $10 million by posting $1.4 billion. The 3.4% revenue growth was very modest, and although encouraging to some, I viewed its EPS miss of $0.03 to be more significant. Sure, its EPS weakness was mostly due to tax items, yet there was nothing impressive from the company to create such a large move higher. The stock is not overvalued by any means, yet I view it as fairly valued because of its modest revenue growth. Therefore, the large move higher could be a bit of a value trap.

The Market Gets this Right ... Then Gets it Wrong!

Alcatel-Lucent (NYSE: ALU) opened in Europe with gains of 8% after posting Q4 earnings that beat expectations, and opened in U.S. markets with gains of 5%. The company reported sales of 4.1 billion euros and a net loss of 1.37 billion euros. However, the large loss was due to a 1.41 billion euro charge. Therefore, the quarter was fairly solid as the company saw 14% growth in North America and 26% growth in its IP division.

Despite the strong quarter, and year-over-year sales declines of just 1.3%, the stock fell lower by over 5%. The company’s earnings, under normal circumstances, wouldn’t look good, but this is a company that is priced with extreme value and is going through significant restructure. Furthermore, the company announced the resignation of its CEO, which was encouraging news at first, seeing as how the stock has lost more than half of its value during his tenure.

The bottom line: This is a cheap company with a price/sales of just 0.20 that is breaking up its losing segments to sell them and become a profitable business that focuses on its growing segments. The company trades with a much deeper value than any other stock in its space, therefore any beat of expectations should have resulted in a massive move higher, and not a change in direction.

Conclusion

A stock’s performance after earnings does not necessarily mean that a company posted a good, or a bad, quarter. Too often we associate stock performance with fundamental performance, yet it’s the inconsistencies between these two factors that create value. The ability to identify these inconsistencies is a psychological behavior changing skill that very few investors are able to perfect. In the past, I have talked about this subject in great detail, and have taught investors how to change these tendencies to return large gains. My advice is to become a smart investor, by learning how to read quarterly reports and assess the quarter without looking at stock performance. Then, if a stock trades incorrectly you are able to capitalize on the value.


BrianNichols owns shares of ALU. The Motley Fool has no position in any of the stocks mentioned. 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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