How, When and Why I jumped a ship named Herbalife – HLF

Last few days have shown why trading momo stocks can be as dangerous as rope walking  in Nepal –

Check out the charts of – DECK, NFLX, GMCR, HLF, SCSS, etc. You think that it cant get uglier then this – Oh! you are so wrong.

Decker is going below $50, GMCR is going below $20, rest are also staring at slide if not doom. These all were once the darling of Wall Street.

Anyways I have owned quite a few of them myself and fortunately, most of the times I have been on the right side, the correct side.

Herbalife was my favourite for sometime –

Amazing quarterly profits and surprises – quarter after quarter, year after year. An excellent CANSLIM, IBD50 candidate. I  bought it after Feb 21st earnings beat at $64.3. It was a beautiful break out.

Rode it till 70s and started taking profits.

  1. Market started to slow down and
  2. all other leaders started going sideways.

so I took 60-70% profit off the table.

On April 30th , it delivered another stellar earning. It beat street by almost 10% but the guidance for Q3 was just inline with consensus.

Stock started correction, but I left a buy order for HLF at $68.5 untouched. These stocks tend to bounce off 50DMA and the report wasn’t as bad as Decker’s report. The stock purchase happened at $68.4. But in morning the tide seemed to have changed.

  1. Stock breached the 50 DMA on heavy volume and
  2. It ripped through the previous support.

Both these event signaled selling by institution had begun. So I bailed out. See a screenshot of actual account trades for 5/1/2012.

Moral of the story is – Never hope and never bring emotion in trading. There is no room for oops!

 

If you plan on entering HLF, I would suggest that you wait. I think HLF might go lower if $50 is breached. This is not the first time people have had negative opinion about HLF. It seems that they really dont have any product – just a marketing company. Moreover Mr. Einhorn does not have a dubious record.

Remember stock price is a speculation of what is going to happen in future. We have plenty of examples as mentioned above such as GMCR, NFLX, DECK,etc.

Dont just blindly follow IBD50. IBD50 is primarily a stock list with fundamentally good companies that are showing good RS (relative Strength). It will just take them one issue to drop the stock from the list but by that time damage will be done to your portfolio.

Lastly if market tells you something then we need to respect it.

There are plenty of companies, which are doing good such as ALLT, TXRH, GNC, WWWW, CRUS etc. Of couse we have oldies that are ready to BO – LULU, ALXN, ULTA, TSCO, UA, URI, etc.

Good Luck!

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Earnings Season is here!

Welcome to the second earnings season of 2012. Alcoa kicked off the season with a big surprise that has stirred a mini rally in the commodity world.

There are a lot of companies that will be announcing their earnings in next few weeks. The bigger and more established stocks tend to be first to announce earnings. The smaller stocks announce earnings later in the season. 

Why do we really bother about earnings –

Back in 1968, accounting professors Ray Ball and Philip Brown famously showed that shares of companies that surpass consensus forecasts tend to perform better than the broad stock market; the phenomenon, which has been backed up by more recent studies, is known as post-earnings-announcement drift, or PEAD. FYI – The same Wall Street analysts who give buy, hold and sell advice on stocks make estimates of quarterly earnings, and pollsters gather those estimates to form a single consensus for each stock that analysts follow.

If the earnings is a major surprise compared to the expectation then the stocks react immediately to the news. Most of the time the stock will make 8 to 25% move on earnings day itself. The investors, in a perfectly efficient stock market, would think that the good news is priced in now and shares of forecast beaters would tend to perform in line with the market afterward. But hold on folks – the most interesting part of PEAD is the D. Shares indeed often leap on good earnings news, but afterward, they tend to gradually drift higher for months.

But not all the earnings surprise are dealt with equally – some companies are just market’s favorites – just kidding!. Nowadays, so many companies regularly beat their earnings forecasts that surprises aren’t always, well, surprising. Some of these companies set the bar low; others perform the accounting equivalent of searching the couch cushions for loose change just before the end of the quarter. Companies long ago got wise to the game, however.

Let’s leave that aside and figure out how to profit from the rigged system and make the best of the D. The gradual nature of PEAD suggests that even slow-poke traders can take advantage.

Ways to profit from profit –

1. Look for firms that beat forecasts by a lot rather than a little. Their results are likely driven by strong operations rather than accounting tweaks.

    • CSTR reported 4th quarter 2011 earnings of $1.00 per share on February 6, 2012. This beat the $0.64 consensus of the 17 analysts covering the company.
    • SCSS reported 4th quarter 2011 earnings of $0.27 per share on February 8, 2012. This beat the $0.22 consensus of the 9 analysts covering the company.
    • ALXN reported 4th quarter 2011 earnings of $0.41 per share on February 9, 2012. This beat the $0.34 consensus of the 19 analysts covering the company.
    • ASGN reported 4th quarter 2011 earnings of $0.20 per share on February 14, 2012. This beat the $0.16 consensus of the 4 analysts covering the company.
    • AAPL reported 1st quarter 2012 earnings of $13.87 per share on January 24, 2012. This beat the $10.16 consensus of the 48 analysts covering the company.

2. Look for companies that beat revenue forecasts at the same time they beat earnings forecasts. e.g. is RHT. Companies that top earnings estimates alone might have done so through cost-cutting, which is fine, but opportunities for cost-cutting can run out quickly. Companies that outperform on revenue, too, are likely benefiting from growth.

A 2006 study published in Financial Analysts Journal found that at any given point, the top 20 percent of companies ranked by recent upside earnings surprises alone went on to beat the market by three percentage points, on average, over the subsequent six months. The top 20 percent by upside revenue surprises beat the market by 2.6 percentage points. However, the top 20 percent ranked by a combination of earnings and revenue surprises beat the market by 5.3 percentage points over the following six months.

In fact a study slated for publication this year in the same academic journal: Watch investor reaction to the earnings reports. “If investors are truly surprised by an upside earnings announcement, the stock price should jump in the short-term,” explains author Haigang Zhou, a professor at Cleveland State University. Zhou and a colleague looked at returns from 1971 to 2009 and found that firms with upside earnings surprises followed by unusually high price gains over the next three days went on to beat the market by 5.7 percentage points over the subsequent 60 trading days.

When to buy them?

Let’s look at the charts of companies that deliver consistent earning’s surprises –

CSTR reported 4th quarter 2011 earnings of $1.00 per share on February 6, 2012. This beat the $0.64 consensus of the 17 analysts covering the company.

SCSS reported 4th quarter 2011 earnings of $0.27 per share on February 8, 2012. This beat the $0.22 consensus of the 9 analysts covering the company.

ALXN reported 4th quarter 2011 earnings of $0.41 per share on February 9, 2012. This beat the $0.34 consensus of the 19 analysts covering the company.

ASGN reported 4th quarter 2011 earnings of $0.20 per share on February 14, 2012. This beat the $0.16 consensus of the 4 analysts covering the company.

AAPL reported 1st quarter 2012 earnings of $13.87 per share on January 24, 2012. This beat the $10.16 consensus of the 48 analysts covering the company.

Earnings offer a lot of opportunities for profitable trading.Most big stock moves start with an earnings surprise. Behind every major multi month or multi month move there is an earnings story. PCLN, AAPL, LULU, SCSS, ULTA, ALXN,BWLD, and many other long-term movers have been primarily driven by their earnings trend. The earning season provides you with the ability to identify such stocks right at the start of their possible multi month move.

As explained above,  most of the time the stock will make 8 to 25% move on earnings day itself. But this is not the end of the opportunities unlike the common perception. The stocks continue to drift higher. In these stocks even if you react to earnings and enter after the earnings announcement, you still can catch bulk of the move.

One earnings surprise is typically  followed by many more earnings surprises. It is almost as if stock’s earnings have gained momentum. When you focus on first earnings acceleration there is good chance your stock will have more such earnings. So effort spent in researching stocks during earnings season can pay you off for many quarters. The structural factors which contribute to earnings acceleration do not disappear in one quarter. That is why earnings trends persist and price trends persist.

So during this earnings season pay attention to stocks that have significant earnings surprise or miss.

When you need to be careful about buying surprises –

There are periods when market goes sideways or goes into correction. During such periods even the best of the best earnings get beaten up. The fundamentals haven’t changed but market is not on your side. Just be patient. Good earnings tend to go sideways during correction.i.e. a correction of 20-25% max with a channel formation or even flag formation or consolidation. This holds good only during correction and not during recession.

So you see above that though the market corrected, the leaders hung in. In fact the market seems to have corrected more than AAPL of PCLN.

Bottomline –

In a good market don’t follow the herd mentality. Do exactly the opposite! George does it.

Deja Vu!

Before we move forward let’s review the market

If you look at the half-hourly chart of S & P 500 for last few weeks you will observe a lot of indecision. This can stem from a market that is awaiting a jobs report or the one that has rallied almost 25% since October bottom but bumping into some bad data or a market that is just waiting for earnings to come out. This is a typical sideways movement that needs just one or two catalysts to either jump up or break down.

Till Friday morning, we were all hunky dory – raising toast to the best quarter since 1998.

But by now, you guys must have heard, read and pondered about the jobs report that came out on Friday morning. Entire market was expecting creation of 205000 jobs with lowest estimate being 193K but to everyone’s disappointment the number came in at 120000. This is exactly the catalyst that I mentioned above. Following is the S & P 500 futures –

Going Forward –

The question is where are we heading from here. Let’s look at the slightly bigger picture –

We will definitely get temporary support at 1375-1370. But that floor might not last long if Alcoa comes out with bad numbers on Tuesday after close. I personally expect the floor to crack on Monday itself. This market might turn into a sideways market or 5-7% correction if this is just one-off jobs miss and not a trend.

The real correction will start if –

  1. We get more of such job reports.
  2. The companies fail to meet Q1 numbers.
  3. Manufacturing margins start contracting.
  4. The inventories start piling up.
  5. Europe’s problem resurfaces.
  6. Israel goes after Iran.

All these events individually have the capability of turning a flat market in to an intermediate/full blown correction. A correction that can go beyond 12-15% – That’s spooky.

In terms of technicals if we fail to hold on to 1336, we are looking at lower lows and lower highs. This means that we are in correction. The breakouts will fail, the industrial sector & commodities will sink and we will stare at repeat of 2011.

Deja Vu!

There is a stark resemblance between job numbers & rally at the beginning of 2011 and the similar macro economic data points in 2012. All of them  fizzled out, making 2011 one of the worst trading year in last 20 years. In case 2012 tries to follow the suit of 2011, I suggest that please sit on the sidelines unless you are nimble (like really really nimble) or you are willing to take 15-20% loss or you want to buy stocks such as QCOM,APA, EMC, etc for long-term. The top traders have always said that it’s good to sit out when market goes sideways and hop in when the direction is confirmed.

This is the kind of summer where I would use the old adage -“Sell in Summer and go away”.

Question is why side ways and why not a full fledged correction?

Never underestimate the Printing Press. One off job report might not bring back QE3 from dead but few of such reports will definitely get Feds going.

 

 

 

 

 

 

Lastly what do we do with current portfolio?

Just as not all fingers are alike similarly different kinds of stock in a portfolio deserve different treatment.

  1. Reduce all the momo stocks such as LULU, ALLT, SCSS, TPX, HLF, ULTA, CLR, ALXN, etc to 1/3 of original position. A risk averse investor might sell all. The reason is the panic grips the owners of such stocks with higher multiples faster than does the rest of the market. Just a reminder, small cap stocks corrects more than larger cap stocks during a correction.
  2. Stick with oldies such as HAL, APA, STX, WDC, PG, COV,etc unless the fundamentals show a major shift such as margins contraction trend,etc. Some of them have already seen fair share of correction.
  3. To defend your portfolio you can buy long term US treasury bonds such as BLV, TLT, etc. They tend to be haven during such corrections.
  4. A very active trader might try putting in shorts such as SH, HDGE, RWM, etc.
  5. Keep an eye on the leaders of this bull and see how they perform during the correction. By leaders I mean – AAPL, ISRG, CMG, SCSS, ULTA, LULU, TSCO, FFIV, etc.
  6. Start running scans to look for stocks with excellent fundamentals that are holding up well. They might be the future leaders.
  7. Lastly add to your existing value positions or buy new ones (after fishing for course) after market has gone corrected by 10%. But remember an oversold market can become more oversold!
  8. Again, In case 2012 tries to follow the suit of 2011, I would suggest that please sit on the sidelines unless you are nimble (like really really nimble) or you are willing to take 15-20% loss or you want to buy stocks such as QCOM,APA, EMC, etc for long-term.

I believe that capital preserved is the capital created for future investment opportunities.

If you are really, really lost, I will talk more about correction, handling of stocks during corrections and going short later on in the week.

By the what do you think?

Thanks For participating!