1Qfiscal17 earnings for Microsoft(MSFT)

MSFT reported a strong 1Q17 after the close last night.

Revenue was up +3% (non-GAAP) year on year.  Operating income was flat, on the same basis, and net up +6%.  EPS was up by +9%, at $.76, exceeding the high end of the expectations of the thirty-odd professional sell side analysts who follow the company.

Growth businesses, like the cloud or the Surface line of laptop/tablet hybrids, were up strongly.  Legacy businesses held their own.  Guidance is for a flattish 2Q17.

 

In many ways, the MSFT report is similar to the Intel (INTC) results from the night before.  Guidance for both companies appeared roughly the same, as well–more or less flat quarter on quarter performance, during a period that’s typically seasonally strong.

The reaction in the press and in the stock price for MSFT, however, was strongly positive.  The stock was up by 4%+ when the results were made public   …and by more than that after the conference call.  As I’m writing this on Friday afternoon, MSFT is holding onto almost all of its after-hours gain during a down day on Wall Street.

INTC, in contrast, fell at all three waypoints–announcement, conference call, next-day trading.

 

Part of the contrast in stock performance has to do with the differing nature of the two companies’ businesses, hardware vs. software.  Part is a function of the greater speed at which MSFT has been able to demonstrate that it is turning itself around.

 

On the other hand, I find it noteworthy that there should be a 10% relative performance difference in two days between the two behemoths who were once the constituents of the former Wintel alliance–and on bottom lines that, if we removed the company names, don’t look all that different.

The rest, of course, must represent two different sets of expectations.  I hold both stocks, which I’ve been studying for over a quarter century (and which I find a little scary).  My expectations aren’t that different.

I’m not simply grousing about being wrong aobut INTC.  I think of investing in the stock market as somewhat like playing a game whose rules each player has to figure out as play progresses.  I’ve often likened the difference between investing in, say, the UK or Japan vs. the US as like that between playing checkers or Sorry and playing chess.

I have a hunch that in reports like these we’re seeing evidence of a change in how the stock market game will be played in the US in the future.  If so, it will be important to catch on to the new state of things as soon as possible.

 

3Q16 earnings for Intel (INTC): implications

Last night after the close, INTC reported 3Q16 earnings results.

The number were good.  INTC’s growth businesses grew; its legacy arms showed unusual pep.  The latter development had been flagged by INTC during the quarter when the company announced wholesale customers were increasing their chip inventories. Nevertheless, earnings per share of $.80 exceeded the average of 29 Wall Street analysts by $.07–and surpassed even the highest street estimate by a penny.

Despite this, the stock fell by about 3% as soon as the earnings release was made public.  Traders clipped another 2% off the share price on the earnings conference call.  During trading today, the stock initially fell almost another 2%, before rallying a bit to close just below its worst aftermarket level.

There was some bad news in the report.  It will cost INTC more than anticipated to rid itself of McAfee.  It also looks like chip customers are no longer so eager to build inventory.  Instead, thus far in the fourth quarter they seem to be subtracting some of the extra they added during 3Q.   The result of this is that INTC thinks 4Q–usually the strongest period of the year seasonally–will only be flat with the robust performance of 3Q16.

 

I find the selling to be unusually harsh (be aware:  I own INTC shares).  After all, if INTC had earned the $.73/share the market had expected, a forecast of $.76 wouldn’t look all that bad.  That outcome, which appears to be the company’s current guidance, would also be better than the analyst consensus had been predicting for 4Q last week.

I’m not trying to argue that the stock should have gone up on this report.  I just don’t see enough bad–or, better said, enough unforeseeably bad–news to warrant a selloff of this magnitude in a gently rising market.

I attribute the aftermarket selloff to some combination of computer trading and thin volumes.  What surprises me is that there were no significant buyers once regular trading–overseen, presumably, by senior human investors–began.

Because of this, I think that trading in INTC over the next days is well worth watching to see if/when buyers reenter the market.  We may be able to draw conclusions that reach wider than INTC itself.

earnings growth: velocity vs. acceleration

velocity vs. acceleration

For investors, earnings velocity is the rate of change of earnings.

Earnings acceleration is the rate of change of velocity.

Examples:

If a company is growing earnings per share at a steady +10% annual rate, it has earnings velocity of +10% and acceleration of 0.

To have earnings acceleration, the rate of earnings growth has to increase.  The growth rate pattern has to be something like:  +10%, +12%, +15%…

Both velocity and acceleration can be negative as well as positive.  If velocity is negative, earnings are shrinking.  If acceleration is negative, the rate of earnings growth is slowing down.  For growth investors, both are bad signs.

as applies to growth investing

Having any earnings per share growth is better than having none.  Having eps growth that’s fast, and faster than that of the average stock, is an important characteristic of attractive growth stocks.

Having eps acceleration is also important.  Its presence typically creates the largest price earnings multiple expansion.

Acceleration is a two-edged sword, however.  Securities analysts looks for signs of earnings growth deceleration as an early warning sign that a company’s period of superior growth–and therefore of its attraction to investors–is coming to an end.  So it’s often the case that the PE will begin to contract, even though absolute growth is high, because that growth is starting to decelerate.

why this can be important:  performance implications

This can create an odd situation between the performance of two stocks, A and B.

Annual growth of A’s earnings: +20%, +35%, +45%, +25%.

Growth of B’s earnings:  +10%, +12%, +15%, +18%.

In the first two years,  Stock A most likely has outperformed Stock B.  By year 4, B is most likely outperforming A, even though the rate of growth of A’s earnings is continually better than B’s.  That’s because A’s earnings are beginning to decelerate, while B’s are not.

 

 

 

 

 

 

 

earnings surprisingly strong, sales a little light–the stock plunges: why?

strong eps, light sales

Sometimes the way that the mind of Wall Street expresses itself in stock prices strikes casual observers as odd.  A prime example of this is when a company (DELL is a recent example) reports earnings that exceed the Wall Street consensus handily, yet the stock doesn’t go up the way you’d expect.  Instead, it drops like a stone.  The market seemingly ignores the strong earnings and points to revenues as the cause of its unhappiness.

Seems kind of petty.

Is there any sense to this reaction?

Yes  ….and no.

the yes part

Remember, the growth stock investor’s mantra has two features:

–surprisingly strong earnings

longer than the market expects.

In situations like the one I describe above, it’s the assumed lack of permanence in the earnings gains that the market is making a negative reaction to.  The argument is this:

Companies make money either by selling more stuff, in which case revenues will rise, or by cutting expenses, in which case they won’t.  So earnings without revenues = cost-cutting.  Cost-cutting opens the door to two bad outcomes:

–sooner or later (probably sooner) the company will run out of expenses to cut and earnings will drop back to their pre-surprise level

–the firm may reducing crucial expenditures, such as research and development or customer service to an extent that future earnings prospects are harmed.  Therefore, earnings won’t just drop back to the pre-surprise level, they’ll fall below that.

the no part

The knee-jerk reaction that earnings growth without revenue growth isn’t a good sign will probably turn out to be right in the majority of cases.  But there can be instances where this is a mistake.

As I’m writing this, I’m struggling to find a plausible concrete example to illustrate what I’m about to say–which tells you (and me) something.

Anyway, it’s possible that a company is composed of a fast-growing, high-margin component and a slower-growing, lower-margin (or loss-making) one.  It may be that new products in the high-margin component are what’s creating the slow revenue, fast profit-growth pattern.  It’s even possible that the company in question is preparing to separate into two parts, either by sale or spinoff, in a way that will remove barriers to investors seeing the full potential of the growth component that the mature one creates.

for a positive market reaction?

For the market to have a positive reaction to strong earnings, light sales, I think three things are necessary:

–the company has to communicate clearly what the dynamics of the earnings situation are (it may have competitive reasons for not wanting to do this)

–professional analysts have got to trust what the company is saying and/or find confirming evidence, and

–investors have to be in a relatively bullish mood, so they’re willing to overlook the bearish signal and believe the bullish story.