Breakout

Earnings Shortfalls: How to Distinguish Opportunity from Disaster

Jeff Macke
Breakout

Facebook (FB) notwithstanding the theme of this earnings season has been the degree to which companies have missed expectations and why. Relative to expectations, this is the worst earnings season since 2007. It's almost a given that a company in your portfolio is going to come up short; the trick is knowing when to buy the dip or head for the hills.

In the attached clip OptionMONSTER.com co-founder Jon Najarian runs through a few earnings whiffs from last week and grade management's handling of the news.

Chipotle (CMG)

Just days after being targeted by short-seller David Einhorn, based in part on competition from Taco Bell, Chipotle found a whole new reason to miss: a Vegas Boondoggle! Buried in the conference call transcript is mention of a $5 million expense covering the cost of taking 2,000 employees to a conference.

$5 million is nothing for a company the size of CMG, but it is indicative of what Najarian says was "a horrible miss." Chipotle is facing economic uncertainty, slowing expansion, weak liquor sales and rising input costs. None of that is in the conference call, but you can hear about a new short movie advertisement. The company also discloses that it's $77 million into a $100 million buy-back.

Chipotle seemed to be the only one involved in the earnings report that was unaware the company had missed expectations and the stock was falling 15%.

Google (GOOG)

Google's third quarter earnings report was bad but not hideous. Some metrics were soft, but the major issue was the degree to which the hardware portion of their Motorola Mobility acquisition is killing them.

What made the release particularly painful was that it came out in the middle of the trading day. Google quickly blamed RR Donnelley (RRD) for putting out the draft but otherwise went, what Najarian refers to as, "radio silent." The stock got halted for nearly an hour then re-opened without further communication from the company.

In the meantime shareholders, many of whom were looking to hedge into the report, were left twisting in the wind. It was akin to "ripping off a band-aid slowly," says Najarian. It only made the pain seem to last forever.

McDonald's (MCD)

The best of the losers, the Dow mainstay, came up short for reasons both predictable and understood. Europe is horrible, currency went against them and Same Store Sales were soft.

Because the company reveals Same Store Sales monthly, investors had every reason to anticipate soft results. As Najarian says, the currency hit was just part of doing business. McDonald's sells hamburgers and obesity. No matter what airlines tell you, hedging commodities isn't a reasonable side business.

Conclusion: It's all in the call

Think of a company that misses estimates as you would a kid who brought home a lousy report card. If they seem utterly clueless as to how they flunked (CMG), it is the worst possible sign. If they simply screw up royally and make it work with bad decisions, you don't need to put them up for adoption just yet, but you should put them on probation, just in case.

If, like McDonald's, the company offers logical reasons for coming up short and seems otherwise in control of operations, it's being as shareholder friendly as is possible under the circumstances. Those are the stocks likely to drop the least and recover the fastest after the selling storm is gone.

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