Earnings Season: How to Watch Your Step

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Stories that involve good advice tend to get re-told, and the ones with real value pop up again and again.

One of my favorites is the story of the legendary admiral who has a lock-box in his stateroom.  Every day before he takes the bridge, he opens the lock-box, takes out a small piece of paper, reads it and puts it back.

Over the years, this quirk is noticed by many people, and there's lots of speculation about what's on the paper: an inspirational quote, a personal sentiment or some gritty piece of military advice?

When the admiral dies, his executors open the lock-box and read the paper.

It says "Port is Left, Starboard is Right."

I've heard this story at least three times, and in one telling it was a merchant captain, in another an unnamed admiral, and in the third, a specific admiral of some fame.

But while the information on the slip of paper would undoubtedly be useful for a man in charge of a ship, I've never seriously considered that the story might be true.  (Although I'd love to be wrong; let me know if you have any supporting evidence.)

As someone who plies the sometimes choppy waters of the stock markets, I know that there are similar sentiments that can help put things in perspective.

If I had to look at one little piece of paper every morning, I'd probably put:

"Remember: When markets are going up, you're not a genius.  When markets go down, you're not an idiot."

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With earnings season just beginning- Alcoa ( AA ) is the traditional first reporter, and it's announcing results today (October 7) after the NYSE closes-there will be plenty of both agony and ecstasy to go around.  And that will make it even more important than usual to keep your emotional equilibrium.

I know that taking an earnings hit can be very painful.  I've had personal holdings that dropped up to 25% after a disappointing earnings report.  The stocks that have been the strongest (which means they had attracted the most hot money) usually drop farther and faster than more sedate issues.  And I felt like an idiot for not taking profits the day before the earnings announcement.

So here are a few observations on earnings season to help you maintain an even keel as the news gaps stocks both up and down with no warning.

1)    It's Not the Number, It's the Expected Number. If all companies had to do to stay in favor with investors was to keep growing revenue and earnings, quarterly reports would be a piece of cake.  But investors pay close attention to the earnings estimates provided by analysts, who, in turn, get to set the bar where they think a company should perform.  So a company can lose money and still "beat expectations" by losing less than analysts thought it would and investors will view that as a victory and bid the stock up.  But even a 100% jump in earnings can kill a stock if analysts had predicted 101%.

2)    Companies Make Predictions, Too. Even if a company comes up to the mark on revenue and earnings, it can get dinged because its projections for results in the next quarter (or year) are subpar. The result is often as bad as for an earnings miss.

3)    Stormy Weather Is Expected. After the rosy Q2 results that put a booster seat under investors' confidence, advance guidance for the Q3 season has been running about two-to-one to the downside.  Among S&P 500 stocks, pre-announcements now total 77 on the negative side and 34 on the positive side.

4)    Don't Fight the Chart. A stock that disappoints on revenue or earnings or guidance or margins or anything and gaps down huge on above-average volume should probably be sold.  Big damage that shows up in a stock's chart can take a long time to heal.  You may be able to pick up a few points by waiting for the bounce that sometimes follows a big down day, but statistically, you're better off selling than waiting for the stock to get going again.


5)    Catch a Rising Star. On the upside, a big gap up on volume typically gives a stock a head of steam that will continue to push the price higher.  So don't let a big gain in a stock that soars on good results keep you from jumping on the bandwagon.  Stocks get good mileage out of good results.

6)    Keep a Razor Edge on Your Sell Disciplines. I've said this before, but it's too important not to repeat.  When you buy a stock, you should calculate your 15% and 20% loss limits and write them down where you can see them.  This will help you to keep your head when bad news hits.  If a stock hands you a 20% loss from your buy price at the close of trading, kick it out!

Here's to a great earnings season with positive surprises in each and every one of your holdings (and mine, too, as long as we're ordering up good luck)!  And as always, I will be rooting for the stocks in the portfolio of the Cabot China & Emerging Markets Report, most of which have scheduled their announcements for November, as is typical for smaller, emerging market stocks.  I'll tell all of my subscribers how to handle the ups and downs for each holding, and I'd be glad to tell you, too. A quick click right here will get you started on a guided tour of the hottest markets on earth.

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If you take the responsibility seriously, recommending any stock is a genuine risk.  After all, mutual fund managers who can pick 51% winners-even with all the research and analysis resources in the world-are considered real gunslingers.  For me, if a stock doesn't meet all of my requirements, it goes on the Watch List, not into the portfolio.

That's why I won't be recommending 51job ( JOBS ) , the Chinese recruiting and human resource company, for the readers of Cabot China & Emerging Markets Report.

The company has lots of things going for it, including its admirable earnings line (up 300%, 233% and 120% from terrible 2008/09 levels) and revenue growth (gains of 15%, 43% and 37%).  After-tax profit margins have been over 20% for the latest four quarters, with an juicy 24.9% in the latest quarter.  And earnings estimates are running at $1.14 per share for 2010, well up from $0.73 in 2009.

51job is a pretty seasoned company for China, founded in 1998 and based in Shanghai, which is the heart of China's commercial zone.  The company serves both potential employers and job seekers, using both online and print media.  The 51job Weekly is a recruiting publication that's customized for particular cities and distributed in newspapers or as a stand-alone.  51job also offers executive search and business process outsourcing services, and will train clients in job skills from secretarial and manufacturing to management and financial planning.

JOBS has been on a roll since April 2009, with a seven-month basing period from December 2009 to July 2010 under resistance at 20.  The blastoff from that base began in July, but really picked up speed (and volume support) in September.

All in all, it's a great package, and the prospects for the company are excellent as China's need for better-trained employees and executive talent heats up.  51job is a very direct play on the growth of China's domestic economy.

So what's the problem?  It's the discouragingly low volume the stock trades at.  With only an average of 150,000 shares changing hands per day, the stock's volatility is just too high to recommend to a large group of people.  It's an appropriate vehicle for the nimble individual investor, but its float of seven million shares will have to increase to make it attractive to institutional investors … and to me, of course.

Sincerely,

Paul Goodwin
For Cabot Wealth Advisory



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: AA , JOBS

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