Credit: Shutterstock photoRegular readers (god bless 'em) will be aware that I generally favor a contrarian approach. That tendency is the result of being trained in the interbank forex market, but it is also just logical.
Traders who have a narrow, all-consuming focus inevitably exaggerate the importance of news, and therefore their reaction to it. That creates opportunity for those that understand that, but it doesn’t mean that every under-pressure stock is a bargain, nor that everything on the rise is over-valued.
That is evident in the story of and outlook for two stocks that released earnings since yesterday’s close, Microsoft (MSFT) and GE (GE).
Microsoft reported after the bell yesterday and continued a run of good results. The beat on both the top and bottom line with revenue of $30.1 billion, versus $29.2 billion expected and GAAP EPS of $1.14 versus $1.08. Still, in an indication of what we can expect to see frequently this earnings season, the stock barely reacted to those very good numbers until the company released forward guidance on anearnings call
Good historical results have become commonplace recently and are largely priced into most stocks. What has prevented that from pushing the market to new highs, however is trepidation about the future. So, when a major multinational like Microsoft reports, even a good beat means very little until traders hear the forward guidance.
Once it became clear during the post-release call that that forecast was upbeat the stock took off, jumping close to seven percent from the after-earnings low before settling around four percent higher than yesterday’s close.
At that point, those beloved regular readers may have expected me to write a piece saying that the positivity was overdone, but that is not the case. Back in early 2014, when Satya Nadella was named the CEO, I said that his appointment was not sexy, but was an excellent long-term move. That assessment has turned out to be accurate, and for the reason given: his focus on Microsoft’s cloud business.
Yesterday’s earning showed that Microsoft is still growing in that area and their outlook suggests even more to come, but traders still seem to remember the pre-Nadella disappointments, and continue to underestimate the stock. That is why, even though MSFT is up around fifty percent over the last year and jumped on these earnings, I have no intention of selling my holdings and expect MSFT to continue to climb.
The other company in focus this morning, GE, is a different story. The contrarian thing to do here, after a sustained but still precipitous drop, would be to buy and in many ways, GE fits my criteria for that kind of trade. There are signs that the stock has found a bottom, having bounced off a level around $12.60 multiple times.
Proximity to that level would set up a trade that appears to have a good risk/reward ratio, which is another thing that I look for. But the assumption there is that there is decent upside for the stock and the structure and blend of these earnings make that even more unlikely now than it was yesterday.
On the surface, GE’s numbers were good. They beat expectations for EPS, albeit by only a penny, but after such a disastrous run the fact that that is their second consecutive beat makes that look significant. There are, however, two problems.
First, the results were only good in the sense that they weren’t as bad as they could have been. The $0.17 of EPS represents a thirty percent drop from last year, at which time GE was already collapsing. Wall Street may have been expecting worse, but however you look at it a thirty percent drop in profit is not a good thing.
Even more worrying though is where that profit came from. The healthcare division, which is scheduled to be spun off, contributed a lot, while the energy business, that will be retained, was a drag. The need for streamlining of sorts at GE was obvious, but results continue to show that what is left of the company when all is said and done will include a lot of unprofitable parts. Even the quick dumping of the terribly named Baker Hughes, A GE Company (BHGE) looks questionable now with oil bouncing around multi-year highs.
It is little wonder then that GE quickly gave back the gains that immediately followed the release of earnings. Relief rallies are seldom durable anyway, and in this case where the relief came from a business scheduled to be cut loose, another challenge of the lows looks on the cards before too long.
MSFT and GE both reported Q2 beats, but the two sets of results prompt two very different reactions. Microsoft’s success is the continuation of a very real turnaround that has seen the company grow considerable, while GE’s profits look more like a flash in the pan produced by shrinkage, not growth. The contrarian approach to those divergent narratives would be to sell MSFT and buy GE, but, as much as it galls me on principle, these are both times when conformity is the best approach.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
