As is always the case when earnings season pushes the averages all around, there will be some market observers that make calls looking for big market moves in the short-term. With many stocks trading near overbought territory, it’s no wonder the chorus calling for a correction of some sort is getting louder. However as has been the case, today’s stock tape continues to defy those looking for pullbacks.
For ourselves, we are more concerned about the stocks that we think make sense with or without any potential pullback scenario. We have certainly seen our list of potential new add-ons for the recommended list get longer of late, but we are still weighing the risk/reward scenarios before alerting our premium subscribers of any changes.
As for today’s market action, earnings results dominated the action. On the plus side, earnings news from the likes of DR Horton (DHI), Valero Energy (VLO), Eli Lilly (LLY), Pfizer (PFE), and Tupperware (TUP), had those shares gaining nicely in the early going. Tupperware also announced a huge dividend increase for shareholders. On the flipside, earnings disappointments pushed shares of Seagate Technology (STX), Ford (F), Polaris Industries (PII), Lexmark (LXK), and T.Rowe Price (TROW) into the red.
For all the latest earnings reports and other important news items affecting dividend stocks, be sure to check The Dividend Daily.
When it Comes to Earnings, Guidance is Everything
I wanted to take our readers behind the scenes and talk about the things we look at when we get into earnings season. Anyone new to the markets that has just started following earnings reports are probably scratching their heads as to why stocks react the way they do.
Why do some stocks report a so-so quarter, but spike higher, while others smash their earnings estimates, but see their share prices tumble? The biggest reason for most stock moves is the future earnings guidance that is given during the earnings call. Wall Street is about pricing the future and not what has already happened. This is the way it has always been and the reason some companies are afforded much higher valuations than some of their peers. We, like most analysts, are looking at sales growth to let us know how much momentum a company may still have. When you look at mature companies (let’s say ones trading in the Dow 30), most of the focus is on the sales remaining in a consistent range. From this range, we can establish the notion of higher dividends as well as the price growth we could see from those dividend hikes. Once growth slows, companies are forced to pay out much more of their dividend payouts from earnings, driving the payout ratio to levels that need to be monitored. Some of the slow-growth tobacco plays have pushed up toward the high end of the payout ratio in recent years, so for investors, these cash-cows need to bought at attractive prices and not chased higher.
For stocks that tend to have cyclical businesses, we need to be very aware of exactly where peak earnings could be. Too many investors have gotten burned buying stocks right at these peaks, because they fail to remember how some sectors trade historically. Plenty of times we have seen PE (price to earnings) ratios fall into single digits, giving a particular stock the feeling of being super cheap, whereas the next few quarters could be when earnings momentum reverses. This happened to homebuilders a few years back. Steelmakers have also seen these booms and busts for decades, and tech stocks always tend to be super cyclical. Interestingly enough, Apple (AAPL) is seeing its PE fall quite a bit, but yet its share price has fallen, confusing many who have been buying into Apple’s story. What the market is telling us is the stock as probably hit peak earnings for now, and it is going through a re-pricing of shares based on where earnings estimates could actually end up being in the next couple of years.
Investing can become quite a science as you see, but the rules tend to remain the same. The toughest part is reminding ourselves that some stocks have had great runs. Leaving some potential upside on the table (especially if you are a trader) and not trying to squeeze the last penny out of a trade is always the safer way to go. No one can consistently buy the very bottom or sell at the very top. For dividend investors, it’s a bigger focus on making sure the stocks you buy into will continue to grow their businesses over time, and more importantly, continue to deliver consistently higher dividend payouts for years to come.
Thanks for reading everybody. I’ll see you tomorrow!
FREE Dividend Stock Newsletter
Get the Dividend.com email newsletter to receive:
- A free copy of our acclaimed report, 5 Rules of Winning Dividend Stock Investing
- Free daily investing tips and picks from Dividend.com CEO Paul Rubillo
- Tons of great market analysis and recommendations