Investors waited with great trepidation on October 25 as two technology giants - Apple (NASDAQ: AAPL) and Amazon (NASDAQ: AMZN) were positioned to release their third quarter results after the bell. A week earlier, the fiasco of Google (NASDAQ: GOOG) was fresh in everyone's minds as the stock tanked massively as a result of an unintended premature earnings release as well as poor performance. Google lost about 8% in a day after huge seesaw action when trading on the stock had to be halted due to the unexpected early release as well as poor results. Since Google, Apple and Amazon are all very popular stocks, Investors were anxious about the results to be announced yesterday because the possibility of a repeat performance weighed heavily in their minds. Turns out, the fears were overblown and let’s figure out the reasons why. It might save our portfolios, at least in the near term!
First, the reaction to a disappointing report from Google appears to have been an anomaly in the current investing environment and attributable mostly to the early and premature earnings release during the day. It was an over-reaction and it is quite possible that had this not happened, the stock would not have lost so much as a result, despite the results. Second, third quarter expectations for most stocks was quite tempered. In other words, the bar was not set too high and when this is so, disappointing numbers typically don't result in a huge stock decline post earnings in such cases. However, after watching the reaction to Google's announcement last week, Investors were not so sure. Therefore, what happened after the earnings announcement of Apple and Amazon on October 25 is important to note.
As of market close on Friday, Amazon was up about 7% and Apple was down about 1%. In light of the fact that Amazon missed earnings estimates and Apple reported mixed results, this is noteworthy. The market usually punishes such stocks when expectations are not met and initially this is what happened after hours and for some part of the trading day of October 26. Then, both stocks rallied presumably because Investors viewed the pull back as a buying opportunity and therein lies the clue!
Fed Chairman Ben Bernanke's third round of bond buying commonly known as QE3 has generated such enormous liquidity in the market that there is plenty of equity purchasing power floating around. Some call this the "Bernanke Freight Train" and an investor better not be in front of it, lest he or she be crushed by it! Bottom line is that if one goes short on a stock just because it is appears quite expensive in a volatile investing environment, it does not mean that this is the best time to short it.
Investors commonly justify stock valuation in terms of P/E ratios and since Apple and Google have forward P/E ratios of 10 and 14 respectively they might very well continue buying. Amazon on the other hand has a forward P/E of 130, yet amazingly enough, the stock appreciated after the earnings report! It would appear that what could be termed "expensive" is simply in the eyes of the beholder.
There are exceptions though. One notable one was Chipotle Mexican Grill (NYSE: CMG). Chipotle dropped nearly 10% after failing to meet estimates. However, in this case there already was considerable overhang on the stock courtesy of money manager - David Einhorn, who recommended shorting the stock due to increased competition from Taco Bell whose parent company is YUM! Brands (NYSE: YUM). Taco Bell has now introduced a new gourmet line called Cantina Bell that supposedly rivals the fast casual menu that Chipotle is famous for. It is important to note that Chipotle’s P/E ratio before the drop was over 30 which together with the rationale provided by Mr. Einhorn led many to believe that Chipotle shares were over-valued.
Of course, it is possible that analysts could come in later and reduce price targets and earnings estimates in light of the Q3 earnings. However, given the price action in play after observing the earnings reports so far, it appears unlikely that there would be substantial downward pressure as a result of downgrades unless they are quite severe. This is not a good time to be a Bear due to the bullish trend of the market despite occasional dips as the market heads towards year end. It is safe to say that while there is substantial concern over the headwinds generated by the prospect of the coming "Fiscal Cliff" which is simply a colloquial term for a coming expected automatic combination of tax increases and spending cuts, the tailwinds generated by the QE3 actions by Mr. Bernanke quite effectively counter it.
So, what is an Investor to do? The safest approach if one decides to buy would be to look for healthy stocks with an excellent growth story that could benefit with attention from investors flush with liquidity. An example is NCR (NYSE: NCR), which is a well-known supplier of Point of Sales (POS) equipment (SEE LINK). It turns out that NCR is a leader in supplying the new type of banking ATM's that have disposed with the use of envelopes for making deposits and directly scan and read checks and cash and send a rich email confirmation. They bring a whole new experience to automated banking and are quite popular.
On the other hand, one could also hold, watch and wait until there is more clarity in the horizon. Making huge bets ahead of the key events mentioned in this post might be tempting, but certainly not the brightest idea and highly discouraged! At the very least, it is best not to discount the Bernanke Freight Train!
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