Should You Buy Stocks That Were Punished After a Solid Earnings Report?

Earnings season is a great time to rebalance the portfolio, not only because the reported numbers tell you what happened in the just-concluded quarter but also the insights gleaned from management comments that throw light on what is to come in future quarters. So when considering whether to buy a stock after the earnings announcement, it’s important to pay attention to both these aspects.

The results tell you how the company has coped with challenges thrown up (in this case, by the pandemic mainly), so you may be able to identify a trend. Like for example, bad news and more bad to come, or good news and more good to come, or hit but recovering, etc. All these scenarios create investment opportunities.

The other thing is the price reaction, which is driven by sentiment and so of course hard to pin down. Because individual investors have varied goals that might include buying for growth or momentum, holding for value, selling for short-term finance or locking in some gains or simply to rebalance the portfolio. In addition, there are the large institutions that have the capacity to significantly impact valuations.  

So on the one side, you have numbers, which are a set of knowns, while on the other you have sentiments, which depend on both the knowns and a very large variety of unknowns. Obviously, you want to factor out risk from sentiments that don’t match yours.

One way of doing this is by checking the valuations. So if a stock is trading somewhere around its median value, you know you aren’t overpaying for it. However, when a company has just reported and analysts haven’t yet gotten down to adjusting estimates, valuations would appear to be more conservative than realistic.

So what to do then? One thing I would focus on is a positive surprise and its drivers to determine if any of these drivers have longer-term implications. Second, I would also check if the guidance was raised or maintained and what drove this guidance. This would tell me if there’s a good chance of upward revision in estimates.

Since in this piece we are talking about stocks that took a beating after posting positive surprises to trade at or around their median value, an upward revision in estimates would justify a higher valuation of shares.

Let me illustrate with an example-

Intel Corp INTC posted some solid numbers yesterday with earnings of $1.23 surpassing the Zacks Consensus Estimate of $1.11 by 10.8% on revenue of $19.73 billion that surpassed expectations of $18.54 billion by 6.4%. However, shares dropped 10.7% in extended trading.

So let’s take a look at the drivers.

Management divides operating units under the data-centric and PC-centric banners. Last quarter’s strength was mainly attributable to the data-centric business (up 34%), where the DCG unit had its strongest quarter ever (cloud was up 47%, enterprise and government 34%, and communications service providers 44%). NAND memory was the other area of strength within data-centric.

While the PC-centric businesses grew 7% on the back of strength in notebooks (Intel has been adding capacity here), sales were likely below expectations as management talked about taking down inventory in the second half.

Despite growing competition, Alibaba BABA, Baidu BIDU, Facebook FB and Tencent added Intel cloud products and even Microsoft’s MSFT Azure had some announcements. Additionally, Rakuten announced the world’s first fully virtualized cloud-native mobile network on Intel technology.

Intel is invested in the emerging mobility-as-a-service category, picking up key ADAS and AV technologies with the $900 million Moovit acquisition. This market represents a long term opportunity that management estimates at $160 billion. Management expects the total addressable market for ADAS, data and mobility-as-a-service together to be $230 billion by 2030. Last quarter, there was a significant design win at Ford F.

Current focus is on key tech inflections such as cloud, AI, 5G, and the intelligent and autonomous edge where there’s scope for secular expansion.

Gross margin missed expectations because of mix issues and 10nm ramp up despite some offset from 7nm costs that were reclassified into R&D, and R&D maintained its general declining trend on a percentage-of-sales basis. Earnings were also impacted by a discrete foreign tax item.

As far as guidance is concerned, Q3 EPS is expected to be approximately $1.10 per share (Zacks Consensus Estimate $1.16). Revenue is expected to come in at $18.2 billion (Zacks Consensus Estimate $18.54 billion).

However, full year EPS is estimated at $4.85, which is above the Zacks Consensus Estimate of $4.82 on revenue of $75 billion, which is also above the Zacks Consensus Estimate $74.01 billion. So there will be upward revision in estimates.

So the third-quarter guidance was a disappointment and estimates for the quarter could come down. The weakness is expected to be in commercial and government PCs as more people work from home. Additionally, the 10nm ramp will hit the gross margin number. It remains to be seen whether the strength it is seeing in cloud and other areas is enough to offset these factors and the higher level of competition.

My best guess is it will be since Intel typically guides very conservatively. The company has topped the Zacks Consensus Estimate at double-digit rates in each of the last four quarters (average 17.4%). So I believe there is upside in the shares.

Other investing factors-

Zacks Rank #2 (Buy)

VGM Score B

Industry: Semiconductor – General (top 23%)

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

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