Path: bloom-picayune.mit.edu!snorkelwacker.mit.edu!americast.com!americast.com!americast-post Newsgroups: americast.ibd From: americast-post@AmeriCast.Com Organization: American Cybercasting Approved: americast-post@AmeriCast.com Subject: NASDAQ Amex Market Date: Thu, 29 Oct 92 13:13:30 EST Message-ID: <12.1992Oct29.131330@AmeriCast.com> 10/29/92 TITLE NASDAQ Amex Market #m#gmrama#m#Profit-Takers Selling Into Strong Earnings Lisa Lee Freeman Picture this: Your stock is a top performer and cranks out yet another phenomenal quarter - earnings are up a better- than- expected 262%. But on the day the news comes out, instead of ral- lying, the stock is reeling. By the session's end, it has lost nearly a quarter of its value. This isn't a bad dream. It was the story of highflying Adaptec Inc. last Thursday. But Adaptec investors aren't alone. This scenario has been played out many times in recent weeks. Other stocks during the current reporting period that were pummeled after posting earnings in line with or better than expectations have included Parametric Technology Inc., Electronic Arts Inc., Intel Corp. and, most recently, U.S. Healthcare Inc. What went wrong? As the old Wall Street axiom goes, "Buy on the rumor, sell on the news." In many cases, investors snap up stocks ahead of earnings in anticipation of the companies beating Wall Street estimates. Then, when companies report earnings, those specula- tors sell. The problem is, if earnings just meet expectations or don't surpass the Street's estimates by a wide enough margin, trading can accelerate into a selling frenzy. Unsuspecting share- holders get clocked and they won't know what hit them. The prob- lem has been particularly bad this year because of increased speculation on and sensitivity to earn- Profit-Takers Selling Into Strong Earnings ings. Explains David Shulman, chief equity strategist at Salomon Brothers Inc.: "What's happening is many analysts are putting out numbers but telling investors to look for upside surprises." The reason, Schulman said, is, "this year the market is more earnings-sensitive because of the lack of growth in the overall economy." The frantic search for earnings has led investors into an ever-shrinking pool of stocks as fewer companies are able to pump out double- and triple-digit profit gains. This concentration on fewer companies becomes dangerous when too many investors try to get out of a particular stock at the same time - especially when that stock is heavily owned by institu- tions, explained Jonathan Schoolar, co-manager of the AIM Weingarten Fund in Houston. "The way a stock trades is very dependent on institutional ownership," said Schoolar. "So you have situations like U.S. Healthcare, where maybe the stock should be down a dollar or two and instead it's down four to six." Adaptec, Parametric, Intel, Electronic Arts and U.S. Healthcare are all heavily owned by institutions. Other charac- teristics they share include a sharp run-up prior to earnings; a history of reporting better- than-expected earnings; and rela- tively high valuations prior to posting quarterly results, which leave little room for disappointment. Market's High Valuation A. Marshall Acuff, portfolio strategist at Smith Barney, Harris Upham & Co., says the stock market's relatively high valuation is partly responsible for the disastrous moves in issues such as Adaptec. The high price-earnings ratio, which is in the mid-teens for the Standard & Poor's 500-stock index, adds more risk into the market, he explains. In Adaptec's case, although results were better than expected, they didn't exceed the Street's expectations by a wide margin, as the firm's earnings have in other quarters. Questions by one brokerage about the company's ability to maintain its high mar- gins also didn't help - although, according to the company, it has been warning of lower profit margins for the past six months. U.S. Healthcare met with a similar fate Monday when its earnings arrived exactly in line with Wall Street estimates and the stock responded by plunging 13%. "The reason is the company had just come through a period of four or five consecutive quarters where it beat estimates by a bunch," said Dean Witter Reynolds Inc. analyst Todd Richter. "So the Street had gotten comfortable with positive surprises, and when it did as expected, it was viewed as a disappointment." Concerns about lower profit margins and higher expenses also contributed to the stock's flogging. Expectations that the company would continue to outdo estimates had been built into the stock. Prior to the drop, its price-earnings ratio hovered 40% to 50% above that of its fellow HMOs, noted Richter. Currently, the stock's P-E ratio is 15% to 20% above the average HMOs. In Parametric's case, fiscal fourth-quarter earnings - posted last Friday - were up an impressive 57% and a couple of cents higher than expectations. But the stock was down 6% by the end of the day. Electronic Arts Electronic Arts' fiscal second-quarter earnings surged a better- than- expected 57% but the stock skidded 11% the day of the an- nouncement. Analysts said it was the first time in five to six quarters that earnings didn't significantly exceed analysts' es- timates. Also, a surprising 17% pickup in profits sent Intel down 5% in the three days following the release of its third- quarter results earlier this month. Despite these few examples, however, the majority of companies that have delivered positive earnings surprises this year have also delivered performance, ac- cording to Claudia Mott, Prudential Securities Inc.'s director of small-cap research. "On average, positive surprises are still working," she said. Small- cap companies that have reported positive earnings surprises in this year's three previous reporting seasons have in the 20-day period after reporting earnings outperformed the Russell 2000 by 2%. So, what can you do to avoid the few land mines? Smith Barney's Acuff recommends greater portfolio diver- sification. "You're probably not likely to make as much money," he said, "but you don't give up as much either." Money manager Gerald Kennedy, of Kennedy Capital Management Inc. in St. Louis, recommends steering clear of widely held and followed stocks such as Adaptec in the first place. He prefers underfollowed issues, which often carry no expectations and, therefore, will con- sistently respond favorably to good earnings. Some of the under- followed issues he likes include software developer Jack Henry & Associates, drug maker Jones Medical Industries Inc. and biotech- nology concern Cytrx Corp. Besides, he said, "overfollowed stocks tend to get overhyped." Schoolar recommends taking advan- tage of big drops that accompany favorable earnings reports. In cases where the fundamental story behind the stock remains in- tact, using the sell-off to buy additional shares can be reward- ing. Also, he said, "you can't simply trade off the (earnings) numbers. You have to do some fundamental research behind them." Sun Microsystems This goes for stocks with good earnings as well as bad. Take the case of Sun Microsystems Inc. After last Thursday's close, Sun reported earnings well below expectations. In response, after- hours traders knocked a couple of points off the stock. But after the market opened the next morning and analysts had a chance to review the numbers, Sun took investors by surprise, soaring 10%. Although the latest quarter was awful, powerful evi- dence emerged that future quarters will improve sharply. Analysts concluded that contrary to earlier indications, the Sun should have enough supply to meet strong demand for a new line of pro- ducts being rolled out by the company. Further, short sellers, which had established a large position in anticipation of poor results, were forced to cover when the stock began to rally. "What looked on the surface to be a terrible number was a posi- tive release," said Schoolar. This article is copyright 1992 Investors Business Daily. Redis- tribution to other sites is not permitted except by arrangement with American Cybercasting Corporation. For more information, send-email to usa@AmeriCast.COM