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OceanJackson (80.02)

Good Quarterly Reports + Stock Drops = Conspiracy Theories

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February 06, 2013 – Comments (18) | RELATED TICKERS: INFN

I'm an amateur investor and by most accounts, just your average joe.  I'd like to talk about something alarming I appear to see frequently: Companies that report great quarters, but drop big immediately on the news! Woo-hoo!  

The 7% drop of Infinera today on beating expectations, and (I listened to every word of the conference call), Tom Fallon's palbable optimism and excitement for 2013's prospects, backed with concrete statements - just doesn't add up. Either did Facebook's nearly 10% drop on turning in a better than expected quarter.  Whenever this scenario happens, we can be assured of hearing lots of simplistic, general, & unfounded explanations for the mystery. 

The last explanation for Infinera's drop I read here on the Fool, was, "Infinera matched on revenue, and beat earnings, but Investors actually wanted more (than Wall Street's expectations)."  That answer and the like, are equivalent to shrugging ones shoulders, putting ones hands up in the air, and saying "I really don't know, it doesn't make sense and I can't explain it, but I guess it just wasn't good enough." 

Another possibility of course is these stocks run up too high pre-earnings, and no matter how good the repoorts are, they just serve as a corrective mechanisms.  I'm not satisfied by this either.  It still happens too often. 

So, what quarterly report's numbers are good enough, if not the Street's stated expectations?  Does The Street have a secret set of expectations they don't let us see?  Ordinary investors would really be hung out to dry then, never knowing what to look for.

I think this perceived frequency of good reports causing stock-price drops should at least be talked about, because I think average individual investors have similar perceptions that something is just plain rotten in Denmark, and it's enough to scare them out of the market. 

Here at the Fool we're all long-term investors, right? And we lift our chins up and say, "value always wins in the end, so we eschew these short-term issues!" Okay, but isn't this more about the investing world we all exist in, than a short-term / long-term discussion?

Here's another explanation for why companies fall on great news, shrugging my own shoulders and rationalizing, however I want to.  Sir Arthur Conan Doyle said, "Once you eliminate the impossible, whatever remains, no matter how improbable, must be the truth."  Big-time institutional investors could in fact be using a secret set of numbers, or, maybe stock-prices have actually run too no matter what the quarter brings, making Doyle's idea here an imperfect fit...But I'd like to offer an improbable, and more insidious explanation: Algorithms. 

The sophistication of algorithms cannot be underestimated, and they rule our market today.  When it comes to companies' stocks dropping, off of great reports, why would we ever guess that algorithms are taking the great news into account?  Does the algorithm say: if input = great news, output = sell?  No.  Rather, if the algorithm knows enough "dumb-money", i.e., money from ordinary average investors have piled into a stock pre-earnings - then might it trigger a trading pattern designed to scoop up that dumb-money?  What do you think people make algorithms for?  Presumably, enough dumb-money sells out and takes some losses - the Algorithm Investor's gains. That should really be their name, shouldn't it - Algorithm Investors.   

Now this may very well be insane, crazy, or idiotic.  I'm not saying it's not any of those things.  But is it that much worse an explanation than, "I guess Investors were expecting more"?  Again, I'm just your average Joe.  And my whole point is - I think many of us average joe's are thinking things like this, about the Stock Market today, and that can't be good. In fact it's really bad.

18 Comments – Post Your Own

#1) On February 06, 2013 at 3:11 PM, MegaShort (99.95) wrote:

"value always wins in the end, so we eschew these short-term issues!"

Value always wins in the end, so when you buy an unprofitable company you can generally expect to lose money. 

Only if you are drinking the kool-aid that expected losses are OK, would the quarterly report be considered good. Sometimes people step back and stop drinking the kool-aid.

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#2) On February 06, 2013 at 3:20 PM, OceanJackson (80.02) wrote:

@MegaShort - It's true Infinera has no earnings yet. It's a fast-grower and relies on the other kind of value a company has - the ability to earn-money.

I was just using INFN as one example though in a larger issue, so didn't want to focus on it.  Unless I'm just totally seeing something that isn't there, this same thing happens to companies with plenty of profits to speak of. 

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#3) On February 06, 2013 at 3:27 PM, MegaShort (99.95) wrote:

"It's a fast-grower and relies on the other kind of value a company has - the ability to earn-money."

Their recent history doesn't look fast growing to me. I understand the hope is that revenues and profits will increase significantly.

As for the ability to "earn-money" as distinct from earnings (or cash flow which is also negative), I don't know what that means.

The effect of beating and falling seems much more pronounced in unprofitable companies and companies with high multiples, than companies with low valuation multiples.

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#4) On February 06, 2013 at 3:49 PM, OceanJackson (80.02) wrote:

@MegaShort -  

Well, the adoption of Networking technology is not as fast as say, the adoption of a McRib Sandwhich.  So if that's the kind of speed you're after, it just isn't found in the Networking world. 

There's no distinction between "the ability to earn-money" and "earnings"? So if you lost your job and thus your paycheck, have you also lost the ability to earn money? And should we not factor into your valuation, your skill, work-ethic, intelligence, etc...as to whether or not you'll make a little money in the future, or a lot?

Doesn't INFN belong to a larger class of stocks that simply show strong potential, with great prospects, and if they hit - will be big?

It's a high-risk high-reward company. 

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#5) On February 06, 2013 at 3:54 PM, OmahaDave13 (< 20) wrote:

On a similar note I find it even more confounding when a stock's price soars on horrible news/earnings.

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#6) On February 06, 2013 at 4:02 PM, MegaShort (99.95) wrote:

OK, I understand what you mean. Earnings potential, as opposed to current earnings. The same metric, more or less, just over different time periods.

I don't know the future of INFN, I just put more emphasis on past results than I suspect INFN shareholders do.

As an interesting sidenote, I recently read an interesting article on the economics of McRibs. http://www.theawl.com/2011/11/a-conspiracy-of-hogs-the-mcrib-as-arbitrage

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#7) On February 06, 2013 at 5:56 PM, OceanJackson (80.02) wrote:

That is a fascinating discussion about McRibs!

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#8) On February 07, 2013 at 10:52 AM, TMFAleph1 (95.72) wrote:

"Once you eliminate the impossible, whatever remains, no matter how improbable, must be the truth."

That's fine when you are examining a small number of seperable explanations. When you're thinking about the stock market, it's inapplicable. There is no need for conspiracy theories when one is dealing with phenomena as complex as stock market movements.

By the way, beating expectations pertains to what a company has achieved in the past. 100% of the stock price reflects expectations for what the company will achieve in the future.

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#9) On February 07, 2013 at 11:59 AM, OceanJackson (80.02) wrote:

@TMFAleph1

Yeah that quote wasn't the most fitting, I mostly just wanted to use it regardless. 

I thought the guidance given by Infinera was pretty good.  They told us that Q1 is when a lot of CapEx budgets are being allocated, when a lot of Network Build Plans are being made, and thus, there's some inherent uncertainty in the industry, it's totally normal.  So they were conservative in their numbers, which is smart. At the same time Fallon did say he sees more Networks being built in 2013 than in the past several years.  He clearly sees 2013 as a big year for Infinera.

So for me, the 10% drop off the report is still a spooky mystery. 

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#10) On February 07, 2013 at 8:47 PM, Valyooo (99.81) wrote:

How is algorithymic trading a conspiracy?  It's legal and everybody knows about it.

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#11) On February 07, 2013 at 8:49 PM, Valyooo (99.81) wrote:

Also instead of hiding behind value always winning in the end you could have used technical analysis and saw triple divergence on the rsi and knew it woud sell off on any news

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#12) On February 07, 2013 at 8:59 PM, TheDumbMoney (58.23) wrote:

Drill this into your head now, or you will have a lot of pain in your future:

The market only cares about the FUTURE expections.  When a company reports earnings, what matters is the outlook, the future, the expectations for that, which nobody knows for sure.  Present earnings only matter insofar as they provide a signal.  There is no conspiracy.  You just don't have all of the data, and you are focusing too much on the data that you do have.  If a company reports STELLAR, RECORD earnings tomorrow, BLASTING PAST ALL POSSIBLE EXPECTATIONS, BUT on the conference call discloses it's going to have a huge sales drop over the next three years and lose money, the stock will get HAMMERED.

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#13) On February 07, 2013 at 9:02 PM, TheDumbMoney (58.23) wrote:

Reading the comments now.  No, there is no "spooky mystery," OceanJackson.  That is a fantasm in your head.  What you perceived (based on what? emotion?) as "smart," "conservative" guidance, the market clearly perceived as crap.  And nine times out of ten the market is right.

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#14) On February 08, 2013 at 11:34 AM, OceanJackson (80.02) wrote:

Fair enough.  I've learned the importance of Guidance just in writing this post.  

I thought INFN's guidance was good. I could have been, and apparently am - wrong.

I'll have to revise how I think about what a 'good-report' actually is. Revenue & Earnings are the ubiquitous figures used for expectations - I rarely hear, "The Street Is Expecting: Revenue, Earnings, and the following Guidance."  When clearly the 'Guidance' factor is as important, if not more important in the case of a company like INFN. 

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#15) On February 08, 2013 at 1:03 PM, TheDumbMoney (58.23) wrote:

It's always possible you're right, and the market reaction is wrong.  If that's the case, that's where value investing and market inefficiency ideas come in.  That's just not usually true.  

In general, I have found that guidance means more the higher the P/E ratio is, because more of the present price realates to expectations about future earnings.  Present earnings are a signal about what future earnings will be, but nothing more.  The are likely a better predictive signal when earnings growth starts from a smaller base rate, though I can't prove it.

You will find that a lot of the way that CNBC and even many print financial reporters talk about investing and earnings, etc., is total nonsense.  

A few people places/people to pay attention to generally are:  Morgan Housel on this website, also reformedbroker.com, and Jeff Miller's blog at "oldprof", the Calculated Risk blog (Bill McBride's blog), and Eddy Elfenbein's blog, crossingwallstreet.  Google all of them and/or follow them on twitter.  You should also read Buffett's letters to his shareholders, at least twenty years of which available online.

For generally bearish takes on the markets today, follow GMO's quarterly letters, John Hussman, Bill Gross's PIMCO notes, Doubleline's Jeffrey Gundlach, and here you can follow TMFAleph1, who posted above, who is Alex Dumortier.  I only agree with about 65% of what these guys say, but they are very much worth reading, very smart, and they may yet be proved right..

DON"T follow Roubini or Taleb for the bearish view: hey are self-aggrandizing charletans who happened to be right once.  More importantly, they DON'T MANAGE OTHER PEOPLE'S MONEY (or even their own to my knowledge) by utilizing their views as a guide.  In general, you should only give a crap about the opinions of people who put money on the line in the service of their opinions.  Opinions about finance, investing, and/or the economy that are not backed by money are worthless opinions.

The caveat on fund managers like Gross is that sometimes they are just talking their book, note. 

If you are interested in trading, not investing, two people worth following are Peter Brandt's blog (he also published a book), and the videos @TraderFlorida that he posts on Twitter.  Most of the rest are not really useful.  Trading is harder than investing.  As much as investing will rip your throat out, trading will rip it out faster and take your lungs, too.  I don't trying to trade as a hobby until you have spent at least a year or two doing virtual trading with fake money and had great results, learned risk management, the importance of stops, etc.

In my view, there are only two ways to win this game if you are a nobody like us:  1) index investing; or 2) time arbitrage -- hold stocks for longer than the people who know more than you do (which is almost all people in this game) care to hold them for reasons other than their level of knowledge; and 2)a) dont' be married to your stocks as a long-term investor; know your thesis, know your companies, and if the thesis gets blown, move on.   And don't invest in shippers or airlines.

Best of fortune. 

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#16) On February 08, 2013 at 3:25 PM, TheDumbMoney (58.23) wrote:

Note that the fact that I highlighted Morgan and Alex doesn't mean they are all I like here.  They are just my favorite writers on this site.

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#17) On February 09, 2013 at 3:46 PM, OceanJackson (80.02) wrote:

@Valyooo  "How is algorithymic trading a conspiracy?  It's legal and everybody knows about it."

To say I blanketly claimed conspiracy against all algorithms is a blatant mis-reading.

Actually I was just making up, inventing out of thin-air, a reason for big stock-drops on strong reports, that's as unfounded but possible as all the other reasons given.

But I do like the algorithm theory, because it fits nicely with the greed that exists in every human-being.

Knowing humans, it's probable that algorithms are not looking at companies, or their reports - they're simply looking at investors, the number of ordinary investors and ordinary investor money that's put into a stock - and acting on that information.  Algorithms designed to take the "dumb-money," with only investor info as inputs.

This is the conspiracy part.  On my conception of human-nature, I would be awe-struck and totally floored - if this isn't what Institutional Investor Algorithm Developers were creating behind closed doors. 

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#18) On February 13, 2013 at 1:34 PM, JaysRage (93.88) wrote:

There are all kinds of reasons why a stock could drop after a "good" earning report.    A "strong" beat might have already been priced in.   Guidance might have been weak.   Risk might have increased.    There is some truth to the fact that heavyweights will move stocks to get out at better price-points, but it should be a minor ripple in your investment thesis, unless you are actively trading the stock.   If you're actively trading the stock, you better be able to predict these movements.   If you can't do that, stop trading the stock.  

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