CWS Market Review – January 24, 2014
“Successful investing is anticipating the anticipations of others.” – JM Keynes
The stock market has been getting bumped around lately, and it hasn’t had much direction at all. Since December 23rd, the S&P 500 has closed every day but one between 1,826 and 1,849. That’s a fairly narrow range, although we are starting to see some behind-the-scenes rotations. For example, healthcare stocks are outperforming as consumer discretionary issues are lagging. The bond market has quietly improved, and the 10-year yield just hit a six-week low.
Of course, the major focus this week has been earnings, earnings and more earnings. The theme so far is that not even good earnings are enough. Investors want to see big earnings beats plus higher guidance. If you don’t have both, you’re in trouble.
We’re still fairly early in the Q4 earnings season. Some 109 of the 500 stocks in the S&P 500 have reported so far. Of those, 74% have beaten their earnings estimates, while 67% have beaten their sales estimates. Unfortunately, those numbers sound better than they are when we consider that going into earnings, many companies had rolled back expectations. Essentially, they lowered the bar to the ground and now expect applause from investors for stepping over it. Well, that hasn’t been happening.
Fortunately, our Buy List stocks have reported very good earnings results so far. Again, it’s early, but all six stocks have beaten expectations. A few beat them by a lot. However, the stocks haven’t been richly rewarded by the market. It’s not just our stocks; no one’s getting any earnings love, and this really shows the market’s ornery temperament.
Make no mistake: I still like the environment for stocks, but we have to come to terms with the reality that the market’s easy gains have already been made. This year won’t be as easy and stress-free as last year was. We’ll still see gains, but we need to be patient and have some humility.
In this week’s CWS Market Review, I’ll run through our Buy List earnings reports. We had especially strong results from CA Technologies and Microsoft. The report from IBM, however, was rather weak, though I wasn’t expecting much.
Later on, I’ll highlight our earnings reports for the coming week. Also, our friends at the Federal Reserve meet on Tuesday and Wednesday. It will be Mr. Bernanke’s swan song, and I expect to see another taper announcement. But first, let’s look at why everyone hates IBM (but me).
IBM Beats Earnings but Falls
On Tuesday, International Business Machines ($IBM) reported Q4 earnings of $6.13 per share. That was 14 cents more than Wall Street’s consensus. That’s the good news. The bad news is that much of that earnings beat was driven by cost-cutting. IBM’s top line numbers were pretty weak. Quarterly revenues fell 5.5% to $27.7 billion. That was $600 million below forecast, and it was the seventh-straight quarter of falling sales.
We know that much of the tech world is shifting to cloud-based networks, but Big Blue isn’t exactly sitting still. The company is aggressively moving toward cloud services, and they’re ditching their lower-margin businesses. They just sold their server business to Lenovo for $2.3 billion. The company also realizes the situation it’s in; the entire senior team has foregone bonuses. On the positive end, I was impressed to hear IBM say that it sees earnings for 2014 of at least $18 per share. They also reiterated their earnings target of $20 per share for 2015.
Simply put, IBM isn’t popular on Wall Street at the moment. The stock got clipped by more than 3% on Wednesday, the day after the earnings report came out. I’m not saying that IBM doesn’t face a difficult environment. It does. Its systems and tech revenue fell 26% last quarter. But IBM has transformed itself many times in its history. Remember that their cloud revenue rose by 69% in Q4 to $4.4 billion.
I think IBM is in a position similar to where Microsoft was one year ago. Bears have been having a field day beating them up, but the stock is cheap now. It’s going for about 10 times earnings, which is far less than the rest of the market. My take: IBM will require some patience, but it’s a solid stock. I rate IBM a buy up to $195 per share.
CA Technologies Is a Buy up to $36 per Share
Also on Tuesday, CA Technologies ($CA) reported earnings of 84 cents per share, which easily beat Wall Street’s forecast of 71 cents per share. Last week, I said the Street’s consensus was “a wee bit too low.” Shows you what I know! Interestingly, this was the third time in the last four quarters that CA has beaten earnings by 13 cents per share.
CA also guided Wall Street higher for the rest of the year. The December quarter is the third quarter of its fiscal year. So for 2014, CA now sees earnings ranging between $3.05 and $3.12 per share, compared with Wall Street’s estimate of $3.02 per share. The company also sees full-year revenues ranging between $4.52 and $4.57 billion, versus the consensus of $4.50 billion. This is what we like to see: beat and raise.
CEO Mike Gregoire said, “Based on our results so far this year, we expect our fiscal year 2015 revenue growth rate and non-GAAP operating margin to be similar to fiscal year 2014.” That sounds good to me. So what did the market do with this good news? On Wednesday, shares of CA rallied by…four cents! Then on Thursday, they dropped by 65 cents. No, it doesn’t make any sense, but you can never argue with traders. Instead, we look at the facts. Going by Thursday’s closing price, CA’s dividend yields 3%. This week, I’m raising our Buy Below on CA to $36 per share. This is one of the good ones.
Both Stryker and eBay Beat by a Penny per Share
On Wednesday, both Stryker and eBay reported earnings that beat expectations by one penny per share. Let’s break down the results.
For Q4, Stryker ($SYK) earned $1.23 per share, compared with Wall Street’s consensus of $1.22 per share. Honestly, I wasn’t too concerned with Stryker’s earnings report. They usually come very close to expectations. But I wanted to hear what the orthopedic outfit had to say about 2014.
For this year, Stryker said they see organic revenue growth of 4.5% to 6%, and earnings ranging between $4.75 and $4.90 per share. That’s a very good number, and it’s well above where the Street was at $4.63 per share. For all of 2013, Stryker earned $4.23 per share.
So with all this good news, what did the stock do on Thursday? It dropped 1%. I don’t get this one either. Stryker remains an excellent buy. I’m raising our Buy Below on Stryker to $81 per share.
eBay ($EBAY), one of our new stocks this year, turned out to be the most newsworthy company this week. For Q4, the online-auction house reported earnings of 81 cents per share, one penny more than consensus. The company also authorized another $5 billion for its share-buyback program.
But the big news came when multi-gazillionaire Carl Ichan said that he wanted to see eBay spin off its PayPal business. Icahn said that he’s going to nominate two of his people for the eBay board. Spinning off PayPal isn’t a new idea, but this is the first time someone so prominent has endorsed it. The board doesn’t like the idea, and they told Icahn so. But the market seems favorable for a spin off. On Wednesday afternoon, shares of eBay were trading up 8% in the after-hours market. On Thursday, however, eBay rallied for a 1% gain.
Frankly, I doubt we’ll see a PayPal spin-off. It’s too integrated into eBay’s business. But I like seeing Carl Icahn advocate on behalf of shareholders. He didn’t get to where he is by being a shrinking violet. eBay had a solid quarter, and it continues to be a very good buy up to $58 per share.
A Tough Quarter at McDonald’s, but Give Them Time
On Thursday morning, McDonald’s ($MCD) reported Q4 earnings of $1.40 per share. That made the company our third earnings report in a row that beat estimates by one penny per share. Sales at the hamburger giant rose by 2% to $7.09 billion. But the details were pretty ugly. Comparable-store sales dropped by 0.1%, and in the U.S., comparable-store sales fell by 1.4%. Ouch.
McDonald’s faces a number of challenges. The new CEO, Donald Thompson, hasn’t been as effective as I would have hoped. They’ve played around with the menu, but nothing has really taken off. The menu has probably grown too complicated and could use some paring down.
The situation at McDonald’s is somewhat similar to that at IBM. The current environment is rough, but the stock is going for a good value. Ultimately, I think the problems are very fixable, but it will take a little time and effort. McDonald’s made about the same profit as one year ago, but thanks to share buybacks, there are fewer shares outstanding, so EPS rose by two cents. The dividend currently yields us 3.4%, which is a nice buffer for us. MCD is a buy up to $102 per share.
Impressive Earnings Beat from Microsoft
After the bell on Thursday, Microsoft ($MSFT) had a very strong earnings report. It turns out that Xbox had a great holiday season. The software giant had a net income of $6.56 billion, or 78 cents per share. That was a full dime more than Wall Street’s forecast. At the top line, revenue rose 14% to $24.52 billion. The Street had been expecting sales of $23.68 billion. The best news is that Surface revenue more than doubled to $893 million.
While Xbox continues to be a great profit center for Microsoft, the Surface is still small potatoes. One big piece of missing news is that Microsoft still hasn’t yet announced who its next CEO will be. Ballmer is out soon. If you recall, there was some speculation that Ford’s Alan Mulally would jump ship and take over at Microsoft. Fortunately, that won’t happen.
Microsoft jumped up more than 3% in Thursday’s after-hours market, but we’ll have to see how it trades from here. Microsoft was a great buy for us last year when it was under $27 per share. MSFT isn’t a screaming buy like it was a few months ago, but it’s still a good value. We also had a very nice dividend increase recently. Microsoft is a good buy up to $40 per share.
Upcoming Buy List Earnings
Still more earnings come in next week. Ford is due to report on Tuesday, January 28. Qualcomm follows on Wednesday, January 29, and CR Bard on Thursday, January 30. These dates may change, so please check our website for the latest. Also, Moog ($MOG-A) is due to report later today.
I’m most looking forward to Ford’s ($F) earnings report. The automaker recently threw a damper on expectations for 2014. The short version of the story is that North America is doing well, but Europe is not. Ford has made it clear they’re playing the long game, so we probably won’t see a turnaround in Europe until 2015 or 2016. Wall Street currently expects Q4 earnings of 29 cents per share, which is down two cents from a year ago. That would be disappointing, but Ford is clearly moving in the right direction. The 25% dividend boost was a great vote of confidence.
Qualcomm ($QCOM), another new stock on our Buy List, will be an interesting earnings report to see. The last report was a dud, and the stock’s subdued performance last year led me to add it to this year’s Buy List. The sentiment is beginning to shift here. If Qualcomm beats and offers impressive guidance, the shares could break out.
Three months ago, CR Bard ($BCR) told us to expect Q4 earnings to range between $1.34 and $1.39 per share. That would put full-year 2013 earnings between $5.70 and $5.75 per share. They should hit that range without much difficulty. Bard is a buy up to $142 per share.
That’s all for now. Next week will be the final trading week for January. The Federal Reserve meets on Tuesday and Wednesday. This will be Ben Bernanke’s final meeting as Fed chair. I expect to see another round of tapering. We have a few more Buy List earnings reports coming our way. On Thursday, we’ll also get our first look at Q4 GDP. The last three GDP reports have all seen increased growth rates, meaning economic acceleration. Let’s see if that continues. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!
– Eddy
Posted by Eddy Elfenbein on January 24th, 2014 at 9:21 am
The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.
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