Five Reasons Why Last Week’s Correction was Unjustified
William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Last week’s earnings announcements made quite an impact on a number of high profile stocks. Global restaurant chain McDonald’s (NYSE: MCD) and software maker Microsoft (NASDAQ: MSFT) posted disappointing earnings that helped push the Dow downward 1.5% on Friday. However, things may not be as bad as they seem. In fact, there were other reports that shed light on improving conditions. Understanding the four themes – currency translation, technological crossroads, improving macroeconomics, and product lifecycle - emerging from last week’s announcements will benefit the long-term investor.
Currency Translations
Adverse currency translations put a huge dent in the earnings of multinationals, despite underlying volume gain. Various reserve banks inject liquidity in their markets by buying mortgages or printing money in order to promote their own exports. When multinationals do business in some of these foreign currencies and then translate the currency into the higher priced dollar their reported revenue and earnings suffer.
McDonald’s revenue was flat versus this time last year, and net income declined 3%. Factoring out negative currency impacts, revenue and net income gained 4% and 1%, respectively. In the European segment, the weakening euro turned a 7% revenue gain into a 3% decline. McDonald’s expansion continues despite currency friction. Once the currency fluctuations ease up, the earnings of multinationals should stabilize.
Technological Crossroads
Many technological companies are at a crossroad. PC manufacturers such as Dell and Hewlett Packard suffer as the standard for computing increasingly moves towards tablet and mobile computing. Intel and AMD’s failure to penetrate the mobile market showed in the chipmakers’ earnings reports, causing a 2% and 21% decline in their stock prices, respectively, last week. Microsoft was no exception.
Microsoft’s revenue and net income declined 8% and 22%, respectively. Microsoft’s less than stellar record at making hardware gives the investing public good reason to lose faith in the company. The Surface, Windows 8, and the new Office software stand to be the biggest coin toss in its history. How well the market receives the Surface and the new Windows platform will tell investors whether Microsoft will retain its relevancy in the future and whether or not Apple will continue to dominate the tablet market.
Improving Macroeconomics
Improving macroeconomic factors in areas such as housing, energy, and the automotive market gave a boost to the top and bottom lines of the western railroad Union Pacific (NYSE: UNP) and homebuilder NVR (NYSE: NVR). Union Pacific’s overall revenue rose due to the sharp increase in freight from the automotive, chemicals, and intermodal segments. Union Pacific’s diverse revenue stream helped it overcome the shortfall in its coal segment.
NVR sales and net income increased 23% and 22%, respectively, amid record housing starts which numbered at 872,000, a five year high. New orders for units increased 15%.
The demand for housing, energy and cars stems from slow growth in employment and good old fashioned supply and demand. Older cars need replacing and people once again realize the benefits of owning versus renting a home.
Product Lifecycle
Microsoft and Hasbro (NASDAQ: HAS) possess product lines at end of their product lifecycle. Revenue in Microsoft’s Windows division declined 33%, the largest decrease of any of their segments, as consumers await the Windows 8 release.
For Hasbro, the lack of a recent movie for product lines translates into waning sales for those segments. Hasbro’s boy’s category, which includes Transformers and G.I. Joe, saw an expected decline of 12%. New movies over the next couple of years involving these two product lines will boost sales. The delayed G. I. Joe: Retaliation is set for release on March 29, 2013.
Looking Forward
Currency gyrations caused McDonald’s stock price to decrease 5% over the past week, creating a better entry point. As the global monetary banks ease up on their liquidity drives; adverse currency translations will become less of an issue.
Of all of the companies discussed here, the uncertainty factor for Microsoft remains the highest. If the Surface doesn’t take off, the sales of Windows 8 probably won’t make enough of an impact due to the decreasing relevance of the PC. Microsoft currently trades at a P/E ratio of 15, a low valuation for those willing to assume the risk.
NVR, with its superior fundamentals, has always outperformed its peers. The recent uptick in housing starts will propel this stock forward. However, with the recent 3% increase in stock price last week and a P/E ratio of 30, any future earnings disappointments will result in a brutal price correction.
Union Pacific will continue to benefit from robust energy, chemicals, and automotive sectors. As I said before, Union Pacific’s diverse revenue streams give the company an advantage. Any improvement in the coal market will improve their top and bottom lines. As long as the American economy produces goods and services, trains will be needed to carry them.
Meanwhile, Hasbro will benefit from renewed interest in the Transformers and G.I. Joe product lines as related movies will be released in the near to mid-term future.
The correction last week was overdone. When temporary conditions improve, such as the stabilization of currency translations, technology companies moving past the technological crossroads, and new products experiencing renewed interest due to fresh marketing, these companies will outperform over the long-term.
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