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Williams-Sonoma's selloff is probably overdone

Stocks to keep an eye on today are Williams-Sonoma and Abercrombie & Fitch. WSJ's Chris Dieterich joins Simon Constable on the News Hub with the details. Photo: AP

After reaching an all-time high and an outsized valuation, Williams-Sonoma (WSM) needed to get everything right with its latest earnings report and outlook. It didn't.

But the degree of selling in the shares following an entirely common event for the high-end home-goods retailer -- issuing conservative guidance that's below Wall Street's estimates -- is arguably overdone. Recently Thursday, the stock was down 10.7% to $66.85, on seven times normal volume, following a third-quarter forecast that failed to meet analysts' consensus.

The idea of being "priced for perfection" is as old as trading, and undoubtedly Williams-Sonoma, with its stellar post-financial meltdown run, was just that, on Wednesday rocketing as high as a record $75.69. Many important valuation measures were ahead of their five-year average readings, including a forward price-to-earnings ratio of 21.9, compared with the normal 18.5, and the P/E-to-growth ratio of 1.6 vs. 1.4.

So Williams-Sonoma needed to be brilliant in its earnings report, as Tiffany (TIF) was. It wasn't, and it's therefore getting the same treatment as laggards Abercrombie & Fitch (ANF) and Guess (GES).

[Related: Abercrombie & Fitch, Guess and Williams-Sonoma fall as sales disappoint]

Note, however, that it was the eighth straight quarter, according to FactSet, in which Williams-Sonoma provided a profit forecast that was short of expectations, this time saying it would earn 58 cents to 63 cents in the third quarter in progress. Analysts were looking for 66 cents. In the second quarter, the company earned 53 cents, matching the analyst forecast that, in fact, was lowered following Williams-Sonoma's call for 49 cents to 52 cents a few months ago.

That wasn't the only disappointment. Second-quarter revenue, up 5.8% from last year to $1.04 billion, and same-store sales, higher by 5.7%, failed to meet the consensus. Based on Williams-Sonoma's opinions, that likely will happen again in the third quarter.

And of course, in the past, the stock wasn't trading above $75. Another old story is that pricey valuations have to be earned over and over again. Many "good" companies -- Whole Foods (WFM) springs to mind -- swoon once the hypergrowth is in doubt. Respectable growth, "good" growth, isn't good enough. Hence, the double-digit selloff.

Holiday help

A calmer approach is of Williams-Sonoma as a company that has much in its favor operationally, albeit one where trading prices could be supported only by an exquisite showing. The owner of its namesake brand, along with Pottery Barn and West Elm, isn't remotely having a horrible time, and indeed it kept its full-year revenue and profit beliefs intact. What that means is it either will have to produce a flawless fourth quarter or at some point say there's a new reality, that it won't earn $3.07 to $3.17 a share. The mean estimate is currently $3.18, down from $3.21 earlier.

The latter option is what has traders and longer-term investors worried for a stock they've driven up 58% on average each of the past five years and, prior to earnings, another 28.5% this year, far above the S&P 500's 8.2% gain. The possibility of another warning is reasonable enough, but the level of panic around the stock is more illustrative of short-term jitters than what the business can turn in. While retail at nearly every income level has been uneven since the financial crisis, the customer with more spending power, as would be at Williams-Sonoma, does have greater insulation. Still, another earnings reduction from here is almost assuredly going to mean the stock goes further south, putting it on management to deliver goods buyers must have for the house.

But with its full-year forecast -- for now, at least -- staying the same, the magnitude of the selling looks harsh with the holiday season approaching. Along with its earnings guidance remaining unchanged, Williams-Sonoma is expecting revenue for the year of $4.65 billion to $4.73 billion and same-store sales up 5% to 7%. It did raise its tax rate expectation slightly, so that will need consideration.

How concerned are the experts? Not really. Yes, that's a strong reason for contrarians to bet on an immediate further decline. Only one downgrade appeared from among the group of analysts followed by FactSet. And while three analysts did lower their prices on the stock, another five raised theirs.