EC Are Risk Factors In Individual Stocks Starting To Matter Again?

“All courses of action are risky, so prudence is not in avoiding danger (it’s impossible), but calculating risk and acting decisively.” –  Niccolò Machiavelli, The Prince

For much of the past few years, U.S. stocks have shrugged off a countless number of risk factors that would normally impact their share prices in an adverse fashion. No earnings? No problem. No revenue growth? That’s fine, as long as you’re buying back tons of your stock. Signs of a potential fraud? No worries, for as long as the stock price is going up it must be fine.

In the short run, investor psychology drives everything in markets. I’ve written a lot this year about the concept of positive sentiment override whereby investors’ positive sentiment bias has overridden any negative news. I’ve argued that since late 2012 we’ve been in the longest sustained period of positive sentiment override in history.

When that period will end is hard to predict but I’m noticing some subtle changes in this prevailing psychology over the past few months.

Earnings

First, on the topic of earnings, there is no better single-stock indicator in my view than Amazon.com. For years Amazon reported declining earnings growth that was not only ignored but often cheered by investors. In the last two quarters, though, things have changed. Amazon reported losses of 27 cents and 95 cents per share and an interesting thing happened. The stock that some have referred to as a “money market” for its persistent advance actually went down. Thus far in 2014 Amazon is down 25%. The importance of this psychological change cannot be understated. If company earnings matter again, it will have broader implications in markets.

risk1

Revenues

Next, on the topic of revenue growth, my favorite sentiment indicator is IBM. Sales at IBM have declined for ten consecutive quarters but earnings continue to rise. Why? Massive buybacks have shrunk the number of shares outstanding, boosting earnings per share. Financial Engineering 101.

1 2
View single page >> |

Disclaimer: This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer ...

more
How did you like this article? Let us know so we can better customize your reading experience.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.
Doctor Zheng 6 years ago Member's comment
Market psychology is always an interesting topic in finance. Thank you for sharing it and listing the examples. I think most traders or investors do not actually do research on the stocks they buy or sell, they just follow the trend and do exactly what the informed investors do (herd behavior).
Rogier Fentener Van Vlissingen 6 years ago Contributor's comment

Right on. However, the issue with Herbalife may be a little more complex for there is a unique situation going on even today with a failure of American regulators to enforce the laws, and even to issue confusing and contradictory guidelines. To this day websites of SEC, FTC, and several state AGs make a distinction between a "legitimate MLM" and a pyramid scheme. Thus regulators have created and maintained the confusion that allows the fraud to continue. Legally things are relatively clear, when the money is made from recruiting not sales, it is a pyramid scheme, and in that light all MLMs are simply pyramid schemes dressed up to create the impression of being real businesses. Presently there are some signs of new interest at SEC (formation of a new task force to combat pyramid schemes), and FTC a forum disussion about how Fraud Affects Every Community, and they are taking the show on the road... in short the abuses of the industry may finally have risen to the level that a sorting out of fuzzy policies of the past may start to take shape. The deterioration at HLF, along with issues at other MLMs, Avon, Usana, NuSkin, and Vemma (banned in Italy for being a pyramid scheme), are all economic /financial indicators that the time to take pyramid scheme regulatory risk for all MLMs seriously has come.