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Sirius: Trade The Reaction, Not The News

Posted
10/25/2013 11:46:00 AM
By: Martin Tillier
Referenced Stocks:SIRI

If there is such a thing as a regular reader of my outpourings, then such a person may have noticed that I often write about earnings stories a day or two after the numbers are released. This is not an accident. I am old and grumpy, so, in a “get off my lawn” kind of way, I cannot stand the trend towards instant reaction. It leads to a focus on headline numbers that can often obscure the real story.

I would rather wait and spend some time actually going through the earnings report before forming an opinion. This can mean missing a short-term trading opportunity on the initial move, but it also means that I get to see the market’s initial reaction before arriving at a conclusion. As I have said many times before, the immediate reaction to news is often more a function of the market’s dynamics and positioning in the stock than of the actual news itself.

There are countless examples of this; a company beats expectations on the top and bottom line and the stock drops, or vice versa. Sometimes, these moves are justified by adjustments to forecasts or something hidden deep in the report, but sometimes they aren’t. What amazes me is that many commentators refuse to acknowledge that sometimes markets move in a seemingly illogical manner.

Thus, when the above scenario unfolds, they look desperately for a reason. Financial pages and channels are full of people explaining that, despite excellent revenues and profits, the 0.5% reduction in capital expenditure or some such nonsense is what caused the stock to fall. Just accept it. A whole bunch of people had bought the stock anticipating an earnings beat and when it came, they sold.

Okay, I feel better now I’ve got that off my chest, but apart from being an enjoyable rant, what’s the point? Sometimes the dynamics and positioning mean that, when a company issues a “mixed bag” kind of report, the market’s reaction is based solely on just one side of the coin. In those cases, trading the market’s reaction is often a better strategy that attempting to go with the flow. Such is the case, I believe, with Sirius XM Radio (SIRI) this week.

You don’t have to be a highly trained (and paid) analyst to look at the one year chart for SIRI and conclude that there may be some longs out there. Interestingly, though, the handy dandy Nasdaq.com short interest page for SIRI would tell us that, as the stock rose earlier this year, so did the short interest. This is natural, especially when the price rise is on multiple expansion. Similarly, it is no surprise that as the move up was sustained, so, in the last month or so, many of those shorts have been squeezed out. I am sure there are plenty of others that will welcome the chance of a relatively cheap cut.

That chance may come following the reaction to yesterday’s earnings. SIRI reported earnings that were 16% lower than last year, and missed expectations significantly. The stock has been hammered, losing about 7.5% from recent highs.

I believe, however, that this may be a case where the headline news obscures the real story. Of course, EPS was disappointing, but there were some positive takeaways too. Sirius increased net subscribers by 513,000 and now has 25.6 million paying customers, representing a 9% increase from last year. The disappointing bottom line is partly attributable to increased taxes, but it must be said that revenue still missed expectations. Probably most devastating to the stock is that the company’s predictions for revenue fell short of the street’s expectations.

When high expectations aren’t met, reaction is often exaggerated, and that may be the case here. If you step back and look at the broad picture, then the future for SIRI doesn’t look too bad. They have so far confounded critics by continuing to expand subscriptions, despite the growth of mobile devices. It seems that most people, while using those devices to access content in many situations, still like the “in the background” nature and simple operation of radio in their cars. This will likely continue.

The stock, earlier this week, was beginning to look a little overvalued, with a forward P/E over 30, but even the company’s conservative looking forecast for the future represents growing earnings, so it will be easy for this correction to quickly become overdone.

It is generally unwise to attempt to catch a falling knife, so I would wait a while before actually buying SIRI. I suspect that somewhere around $3.60-3.65 will turn out to be a decent level to get in, but my advice would be to wait and see. You are not necessarily trying to hit the bottom of this move, so waiting for buyers to emerge before joining in is probably a good idea.

This is what I mean by trading the reaction to the news rather than the news itself. If you had reacted fast enough and sold on the miss, you would be doing fine, but given the tendency of traders to over react, there may be even more to be made by those who wait, and buy when the price begins to turn back. Maybe it’s because I’m getting old or it’s just another sign of my contrarian nature, but in these days of instant reaction, taking a day or two to react, then attempting to benefit from an overreaction, is increasingly appealing.