Earnings can dictate the direction of a stock for the following three months. Investors pay close attention to earnings and often make emotional decisions based on the performance of a stock post-earnings. However, the performance of a stock following earnings should never be the first line of research, rather the last. With that being said, I am looking at three companies that reported earnings on Friday, and these are three stocks that I’d be careful when buying.
Modest Growth & Expensive Stock Lowers the Chances of Long-Term Gains
Cerus Corp. traded higher by 11.25% last Friday after reporting earnings that slightly exceeded expectations. The company reported sales growth of just 6% year-over-year (yoy), but investors were optimistic with its 14% yoy growth in demand for Intercept disposable kits. Furthermore, the company saw its gross margins of product sales expand to 51%, compared to 37% in Q4 of 2011. This too added to the gains.
While Cerus’ earnings were solid, the company’s 6% growth and $10.5 million in total revenue is not enough to validate its $200 million market cap. This is an unprofitable company trading with a price/sales of 5.0 with very little year-over-year growth. This is a company that has seen five years of consistent revenue and margin growth, and on Friday the market apparently rewarding the stock for its consistency.
My problem is that the company is still not profitable, and is not expected to achieve profitability within the next year. Cerus has a large sum of cash, more than $20 million, but also has debt of more than $8 million and an accumulated deficit of $460 million. To me, the company’s growth compared to valuation does not make sense, and I’d be very careful buying at these levels.
Huge Quarterly Miss Blinds Investors of Potential Long-Term Problem
While Cerus traded higher by double digits on Friday, shares of Foster Wheeler traded lower by double digits (15.96%). The reason for this loss was a wide miss on both the top and bottom line. The company posted an EPS of $0.27, missing expectations by $0.19, and revenue of $735.3 million, missing the consensus by $241.25 million.
There are some investors who might think that now is the time to buy Foster Wheeler after its big loss. The stock is trading at just 0.67 times sales and has a P/E ratio of 15.92, therefore conventional wisdom may suggest that the stock is presenting value. However, I disagree.
This is a company that was expected to post a full-year EPS of $2.05 in 2013, but on Friday revised guidance to just $1.54 (a 25% miss). The company also announced that $978 million worth of new orders were booked. This might sound good, but this is down from $1.51 billion in the year prior. As a result, considering its guidance and the presumed revenue weakness from falling orders, I don’t see how the stock is presenting value.
Great Growth But Too Expensive
Splunk , a machine data analytics leader, rallied almost 8% on Friday after beating on both the top and bottom line. The company posted an EPS of $0.03 and revenue of $65.2 million, a 51% yoy gain. The company’s 2013 guidance of $260 million-$270 million is also above the consensus of $263.2 million; that is if the company’s revenue is near the top end of guidance.
If Splunk achieves revenue in the middle of its guidance then growth for 2013 would be approximately 50% compared to the last 12 months. This is a company that has grown incredibly over the last four years, doubling in size during each of these four years. Now, growth is slowing to 50%, the company is still unprofitable, and it’s trading with a ridiculous price/sales ratio of 20.14. Therefore, the stock is trading at 15 times next year’s sales, with a forward P/E ratio of 389.70.
Now, I am not saying that the stock will not rise from this point. However because of its valuation the upside is limited. As a result, retail investors might be better served finding other companies with 50% growth, or greater, that are trading with much more attractive margins (ie SodaStream, XPO Logistics, Jazz Pharmaceuticals).
In my book, Taking Charge With Value Investing (McGraw-Hill), I examine human behavior and the psychological effects that take place in the minds of investors when a stock shoots higher or falls drastically lower (think roulette at a casino), with one scenario being earnings. For many investors, chasing these trends is common, even addicting, and very few are capable of realizing their losses because of their occasional gain.
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