Clear the Noise: One Time Mistakes are Opportunities
Nikhil is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
As we enter the earnings season, opportunities are everywhere. The market's dramatic short term corrections following quarterly announcements create a wealth of opportunities to buy quality growing companies at cheap prices. A strategy of buying based on one time business weakness in quarterly results could be very profitable.
Not only is this buying strategy sound fundamentally, but Buffett himself employed this strategy in his investments. For example, Buffett only bought American Express (NYSE: AXP) in 1964 because it was caught in a fraud scandal, a short term calamity that had a large effect on share price in the short term. As Buffett realized the hype on American Express was overdone, he invested at low prices and waited for the noise to clear. By 1967, the price had gone from $35 to $180 per share, creating an investing tale that has been told far too many times.
Opportunity Abounds: It's Our Job to Take Advantage
The obvious issue for us, the individual investors, is trying to differentiate between news that shows a company is losing its life and news that shows the company is having a little bad luck. So instead of just giving you my ideas of where opportunity lies in the market, I'm going to describe the situation and clear the noise. With that in mind, the psychological effects of the company and its stock chart might not effect you quite as much. The goal here is to understand the mindset of an overreaction based investment, where the market and analysts everywhere are urging you to sell. Take a look:
1. This is a company that has averaged a 22% Return on Equity in the last 5 years. In the last 12 years and the last 5 years, this company has compounded net income at 32% and 24% respectively. Asset Growth has been fueled by a sizable growth in equity rather than growth in liabilities(as seen in the picture below).
The company has two enduring brands and has made a new growth acquisition recently. However, recent problems have caused a 35% drop in the stock price over the last year and despite this rampant growth, the company sells for just 11x earnings.
The problems are: 1. Higher prices of their necessary commodity, 2. A Mild Winter This Year, and 3. Fears that their brand is a passing fad. While fears about their brand strength persists, revenue increases continually. The stock is hit hard because the company's margins are compressed with high commodity prices and the mild winter caused the company to fail to hit growth levels expected by management. The company, whose 7 year tenured CEO owns 16 million dollars of stock is near 10 year P/E lows and expects EPS of $4.5 next year due to these short term problems. Would you invest?
That company is Deckers Outdoors Corporation(NASDAQ: DECK), and it's currently being blown up by bears who fear lower growth in the next 1-3 years due to investment in European expansion combined with higher commodity prices eating into profit margins. Despite all this talk, what I see is a company that continues to improve revenues through international growth while it waits for sheepskin prices to resume their normal levels. I believe that the multiples this stock currently supports are in no way merited and I see an intrinsic value of $65-$75 for this stock, as the resuming of growth should merit at least a price of 15-16x earnings.
The Buzzing Isn't Gone!
The goal of this exercise was to clear doubts about Deckers Outdoors Corporation that are made in the short term by showing you long term company success and a long term vision for the company's future. However, I bet there are plenty of smart investors out there who weren't convinced. Frankly, who knows if higher sheepskin prices is a short term issue? And what if Uggs, Deckers' primary brand, is actually fizzing out?
The simple answer is you don't have to settle. That's the beauty of earnings season. There are plenty of opportunities to use that long term perspective, so if you aren't comfortable with one you can just move on to the next. To close, here are 2 stocks I would recommend looking into further after they have been recently bashed by quarterly earnings reports:
1. Tempur-Pedic International (NYSE: TPX)
Down 30% in the last month, Tempur-pedic was hit hard when they didn't raise forecasts as expected. I don't know why, but when a company's expectations of 18% Earnings per share growth remains unchanged, I don't see that as a reason to knock the stock 30% lower. Analysts started clobbering them for having "increased competition" and "commodity headwinds" when the company has clearly stated that earnings are slowing due to investments in growth of a new brand. Tempur-Pedic International's expected EPS of 3.8 to 3.95 gives shares a Forward P/E of 15.5 and a potentially sweet entry to a normally expensive stock.
2. Infosys Limited (NYSE: INFY)
Down 18% in the last month, Infosys was hit when they met analyst expectations for EPS and slightly missed on expected revenue. The real hit was weak full year guidance, but management clearly has shareholders in mind as it declared a final $0.43 dividend as well as a $0.20 special dividend. While the quarter was difficult for Infosys, it's superb growth and management have done well thus far, making it worth your while to check the company out while it's at its lowest stock price since Nov. 2009.
Earnings Season is a wonderful place for the opportunistic investor, and I believe the opportunities from market overreaction make the possibilities for investment endless.
shamapant has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend American Express Company. 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. If you have questions about this post or the Fool’s blog network, click here for information.
