Earnings and earning-related news is the number one catalyst for stock movement. A strong quarter can dictate the direction of a stock for the following three months as can a bad quarter; in the past I have written in detail about such subjects, a domino effect reaction following a strong or bad quarter. However, sometimes the market gets it wrong, and stocks trend incorrectly. Therefore, I am looking at three big time post earning reactions to determine if the market got it right.
A Bad Quarter, But Not That Bad!
Level 3 Communications, Inc. (NYSE:LVLT) was the biggest loser of the day with its 13.58% loss. The company posted revenue of $1.61 billion and an EPS of ($0.26). The company actually beat on the top line but analysts were expecting a loss of $0.07. Naturally, the stock fell significantly lower. However, there were strengths within the quarter that were obviously ignored.
The company’s decline in core network services showed a slight quarter-over-quarter decline, but it was only due to seasonality issues. The company’s Q4 gross margins were 59.4%, a 120 basis point rise over last year. Level 3’s adjusted EBITDA for the full year showed 20% growth, which was at the low end of guidance. Overall, there were weaknesses, but also some strengths. The quarter wasn’t as bad as the reaction; Level 3 generated $202 million of free cash flow versus a loss of $157 million last year.
The stock is trading with a price/sales of just 0.84 and has a forward P/E ratio of 56. Therefore, the company is improving, but could slip lower. The stock has traded in a tight range over the last year, with the low being at $18.50.
With that being said, I would take a long hard look at the stock if it slips another $2.00 below $19.50 due to its trend. The only reason I say $19.50 is because the stock is so trendy, otherwise I believe it’s fundamentally worth the buy after today’s inappropriate reaction.
Too Many Questions Leave Concern
Spirit AeroSystems Holdings, Inc. (NYSE:SPR) is a capital goods company, known as the maker of airplane parts, that rose 5% after reporting earnings. The company’s results were mixed compared to expectations, but because of a 40% loss over the last year, decent was treated as good.
The company posted revenue of $1.43 billion (beat expectations) and an EPS of $0.43 (missed expectations). Its revenue growth of 17% was strong as the company’s backlog increased 4% to $35 billion. However, the company, a major supplier to The Boeing Company (NYSE:BA), didn’t say anything good or bad about Boeing’s 787 and didn’t indicate that there could be fundamental problems due to the airplane’s troubles. Spirit went on to reiterate its 2013 outlook, which was on the lower end of expectations.
My problem with the move higher is that there was nothing particularly good within the report, and that the company did not mention the 787. As an investor, I would be very cautious of chasing gains with this stock, as the situation with Boeing remains volatile. Over the last month there have been whispers that Boeing’s issues are more than just battery-related, and if more problems continue then the company could begin to point the finger at its suppliers. Therefore, with all things considered, I am not sure how the stock could be a “buy” at this point in time.
Stock Rockets on Somewhat Bad Earnings
Avon Products, Inc. (NYSE:AVP) posted a wider than expected quarterly loss, saw sluggish growth trends with total units higher by just 2%, and it continues to have high exposure to Venezuela. So with these problems in mind, how did the market respond to such weak points? The stock rose by more than 20%!
Investors looked past what were obvious weaknesses because of company write-downs and a “business plan” that is geared toward saving on costs. To the company’s credit, I must say that Brazil and Russia were bright spots, but still there were way too many negatives for such a great reaction. Let’s not forget, almost always, cost reductions mean slower growth as companies focus on margins. In a very competitive market I am not sure how cost cutting will serve the company. I view this action as a huge risk and a reaction that was unwarranted.
Conclusion
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 logically assess what caused a stock to move compared to its valuation, or by learning how to first read a quarterly report before admiring the stock’s reaction. Then, if there is a distinction in value you are able to capitalize on the value.
The article Three Post-Earning Reactions Presenting Value originally appeared on Fool.com and is written by Brian Nichols.
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