As we start to close the books on the second-quarterearnings
season , a clear trend is now official: companies have struggled to
boost sales andprofit margins appear to have peaked, which has led
to a higher-than-usual amount of lowered guidance for the quarters
ahead.
Yet, there are always exceptions to the rule, and if you dig
deep enough, you'll find stocks that managed to deliver blowout
results. Either analysts were simply toobearish in their forecasts,
or these companies are truly finding more ways to squeeze out
growth. Either way, surpassing profit forecasts by 30% to 40% or
more is nomean feat.
But that doesn't make these stocks a bargain. Sometimes
investors get carried away, extrapolating current strength well
into the future, and boosting these stocks up into a "can't miss"
level. That is to say, these stocks are now so richly valued, that
they dare not miss futureearnings per share (
EPS
) forecasts, or theirshares will take a tumble. Case in point:
these 12 stocks delivered robust second-quarter profits, but
theirprice-to-earnings ratio on projected 2013 profits may now be
too rich for thismarket . Each stock trades for a higher
forwardmultiple than the average multiple of stocks in the S&P
500.
That's why it's wise to focus on stocks that show clear profit
momentum -- relative to analysts' forecasts -- and sport decent
valuations. In late July, I profiled stocks that were
delivering robust profits as earnings season was getting underway,
which you can
read about here
.
Though bank stocks were the most intriguing names back then, the
crop of estimate beaters that have delivered results since have
shown no clear theme.
Of course, you have to dig into the reasons why a stock is
delivering very strong profits. In the case of investment firm
Kohlberg, Kravis & Roberts (NYSE:
KKR
)
, an upward valuation in of its portfolio holdings, Alliance Boots,
accounts for almost all of the upside. That's obviously a one-time
event.
Computer disk-drive maker
Western Digital (NYSE:
WDC
)
repeatedly delivers robust quarters:EPS has topped the consensus by
at least 35% for each of the past three-quarters. Yet, analysts
still say traditional hard disk-drives will losemarket share to
solid-state (flash memory) drives over the long haul, and they
foresee a steady erosion in sales for Western Digital beginning
next year.
Two stocks to consider
But some stocks deserve credit for holding up well, even if its
industry conditions remain difficult. For example, apparel retailer
Jones Group (NYSE:
JNY
)
is struggling with weak foot traffic in its stores. Sales are
likely to be flat this year at around $3.8 billion, millions less
than what the company generated in the middle of the last decade.
But management has kept a tight lid onoverhead , and its
merchandise selections are leading to solid gross margins, which
have allowed the Jones Group to surpass EPS forecasts
handily. You can only assume profits will be even stronger as
theeconomy improves. Meanwhile, shares trade for a reasonable
valuation in this era of depressed results.
The profit upside from wireless services provider
MetroPCS (NYSE:
PCS
)
came from a tight control on costs as well. The company's
value-oriented approach has enabled it to retain its subscriber
base, even as rivals have moved more quickly tooffer more advanced
voice and data networks. But the decision to focus oncash flow and
not sales growth has lead some to think that this company is primed
to be acquired.
Bigger players such as
Sprint (NYSE:
S
)
,
Verizon (NYSE:
VZ
)
and
AT&T (NYSE:
T
)
, are dealing with a fairly mature market and have hinted that
deal-making may be part of its growth plans. Merrill Lynch doesn't
expect that "a buyer emerges through the end of the year, at least
because of the chaotic state of current spectrum environment."
Right now, a number of firms are looking to buy, sell or trade
their wireless spectrum to optimize coverage.
Sprint is the most likely buyer and the company is getting into
a stronger competitive position, which I
profiled here
.
Though Sprint concedes that it doesn't want to look at deals
until its own network upgrade and expansion efforts are completed
next spring.
But for now, MetroPCS remains focused on delivering robust cash
flow, which should support shares in advance of any potential
futurebuyout .
Risks to Consider:
MetroPCS and Jones Group have long-term catalysts in place, but
must deliver good results in the near-term. Each of these firms'
focus on costs and margins have been quite helpful, but those
inputs are now baked into analysts' models, potentially capping
further upside relative to forecasts.
Action to Take -->
Delivering estimate-beating results in a challenged economy sets
the foundation for even more impressivebottom line results during
the next few years when the economy is finally on the
mend. Though the stocks in the first table of this column
appear a bit pricey now, keep an eye on them as a sharp market
pullback would likely bring them into value territory, which could
be helpful if they deliver estimate-beating results in the next
quarter as well. The stocks in the second table, however, appear
cheap despite their recent estimate-beating results. The two stocks
I mentioned earlier, in addition to others in this table, might be
worthy portfolio candidates.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.