Earnings Announcements, Update, and ASPV Thoughts

I've only been through a couple of earnings announcement seasons, now, but it seems like an exciting time. Like Piotroski said, something like 1/6 of a stock's movement comes over the combined four days of the year that the company annouces earnings.

DECK kicked butt, reporting $0.83 per share, up from $0.63 compared to the same quarter last year. This blew away analyst estimates of $0.54, and the stock price jumped ~ 8%.

ISNS stunk it up. BLD was flat with last year. ALDN beat estimates by $0.03, and stayed pretty much flat, also.

SCSS came ahead of analysts estimates, but said that sales slowed towards the end of the quarter and so the stock price slid 17%.

Income nearly tripled for ATHR with 74% increased sales.

ARNA lost $20M on R&D, and stayed high, still for no real reason. It seems to have settled at ~$15, and as long as it stays around here, I'm happy.

Merck bought Sirna at a huge 100% premium. This sent ALNY up ~20%, as pretty much the only independant microRNA company left. Pretty sweet.

That leaves one company, which I'll save for the end of the post. My three portfolios are up. That's a pretty big thrill for a beginner like me. The biotech portfolio is not doing as well as the biotech indices, even after ALNY's boom. I still have some faith in CBST, but it is wavering a little. Basically, as it begins to show consistent profit in the next few quarters, I'd like to think that the share price will go up. However, as I'm starting to figure out, part of that expectation is already priced in, so CBST has to perform particularly well. That is the source of the wavering faith in it. NOVC seems to have some on-deck drugs in late-phase trials. Assuming those go moderately well, it'll spike. I'm pretty happy with both my MFI and HG portfolios. These are beating the market, and kicking butt compared to the Russell 2K. There has been discussion on the MFI board as to whether the system relies on a few really big winners, or whether most stocks move towards large gains. My results so far have 3 winners above 20%, 2 more 9% or greater, several that are within 5% of even, and one big loser. This is only after 4 months, which means that this is statistically meaningless, and also that anything can still happen. Finally, half of my most recent six HG picks are in the teens of returns, and half of my first set of picks are absolutely kicking butt. WLT is at 6%, and the others are nearly flat. Pretty darn good for the first four months.

There is one major caveat that I need to keep in mind. Of everything that I bought, I was really excited about ASPV. And that has proven to be the biggest loser so far. So I'm not a good stock picker: I'm lucky. From everything I've read, the longer I can keep that in mind, the better I'll do in the long run. So from now on, every time that I pick any basket of stocks, I'm going to predict which ones will do the best. I expect that these rankings will not at all correlate with actual performance, but will instead serve to keep me humble.

Finally, I want to talk about ASPV. This one is a whopper. First, it announced that it would miss analyst estimates for the quarter. It reiterated that for the year it would make 163% of last year's earnings. But still, it dropped 10%. I thought that was way less bad than the market thought. And then they announced that their drug didn't pass phase III trials for another indication, and the stock dropped another 11%. At this new price, the PE is ~6.5 TTM, with a forward PE of ~5.3. All of this together got me thinking. The CellCept patent runs out in 2009. So shareholders can count on about 2-3 more years of great earnings, and then the well dries up. Unless, that is, the company finds either another drug or another indication for their drug. It's a bit of a desperation situation. Another way of looking at this is: the PE is the number of years it takes for the current earnings per share to pay back the investment. From this perspective, investors at this point are betting 2.3 years worth of earnings that the company will find some way to remain profitable beyond the patent protection of CellCept. If they do find some way to remain profitable, the PE should shoot up to some amount beyond the patent protection or other limit of the new drug in question. The years worth of betting on management amount to 43% of the PE. Cash per share, after subtracting the miniscule amount of debt, is $5.50. So of the remaining cost of the share, is 43%, or ~$5.60, represents the bet that management will find a new drug, or a new indication for their drug, within the next few years.

Cubist's Earnings and the Market's Expectations

Clearly, I am still learning how the market 'thinks' - how it reacts to news.

Cubist announced the other day that it had its first profitable quarter ever. But it was under analyst estimates of revenue (~$50M vs. ~$54M). So it lost 6% in afterhours trading immediately following the announcement. Whatever the analysts' estimates, though, this is still a 58% increase over Q3 last year! I would have thought that would be enough for shareholders, but apparently not. Non-GAAP income was $0.14 per share, while GAAP income was $0.09 per share, compared with a loss last year of $0.08 per share. Isn't this a good thing? After a morning low of $21.21 the day after the announcement, the market decided this was all good news, and shares peaked at $23.18. That's a 9.2% total change from valley to peak! Just because of the market being indicisive!

In The Intelligent Investor Today, Larry Swedroe makes the point a few times that the market prices in expectation. So a downturn after missed earnings is something that I can almost understand... Except that analyst pricing is notoriously inaccurate. I'd think that investors would take them as rough guestimates rather than as precise numbers. In fact, analysts have a tough time getting the direction right, let alone a specific number by a specific date. (Swedroe talks more about macroeconomic analysts, who try to estimate general market trends; probably analysts do better on specific stocks with defined products and markets.) Givn all of this, wouldn't something close to analyst expectations be at least neutral if not positive? More importantly, shouldn't the milestone of the first profitable quarter help a company rather than hurt it? Obviously, I wasn't the only one expecting good news this quarter. But was that good news priced into the stock? I don't believe that there's an answer, because the stock yo-yo'd and ended up maybe a percent or two. From the close of business prior to the earnings announcement to the close today, CBST is up 3.5%. This may be nothing but noise: The NASDAQ is up 0.76% in the same period. Is this a significant difference? Maybe it is, now that I see the numbers. But the beta for CBST is ~3, so maybe this is just chance and nothing more. In other words, are we looking at an efficient market or a foolish Mr. Market? I still don't know.

Efficient market vs. semi-efficient market vs. inefficent market

I'm reading The Successful Investor Today by Larry Swedroe. In this book, it is argued that the market is efficient. This means that all relevent news is rapidly distributed and incorporated into the price of a stock. The usually-discussed alternative is an inefficient market. Most value investing books seem to work off of this principle. I don't have specific references handy, but I'll bet on Joel Greenblatt and anyone who uses the classic analogy of "'Mr. Market." I think this comes from Ben Graham. Mr. Market is moody, and on any given day is going to change his mind about what exactly a stock is worth. In the long run, though, Mr. Market gets it right.

The Successful Investor Today describes the market as efficient based essentially on the following argument: For every buyer, there is a seller. So if someone gains, then someone loses. This is not what is usually meant by an efficient market. In fact, this describes a zero-sum market.

I would argue instead that the market is semi-efficient. On any given day that there is relevent news, that news is indeed instantly distributed and the market price of a stock more or less reflects the impact of that news. However, the daily fluctuations, and gradual drifting away from that more-or-less accurate pricing represents the inefficiency of the market. I read somewhere recently (I think it was the Piotroski paper) that 1/6 of the total change in a stock price over the course of a year occurs over the four days when the company announces quarterly earnings. Look at what happened to PLAY when their one customer, Apple, announced that it would no longer buy their product. Look at what happened to NBIX when the FDA refused to approve indiplon. PLAY lost something like 60% of its value in one day; NBIX lost 40%. That is efficient. But, the drift of any one stock, or even the market as a whole, is noise. Read Fooled by Randomness - almost everything else is noise.

So that's my conclusion. The market instantly takes into account any important news. However, it slowly seems to forget whether the news was good or bad and drifts around the price to which it revalued the stock.

I'll add one additional comment: sometimes - on rare occassions - the market doesn't seem to fully take into account particular pieces of news. I've already discussed the LPMA acquisition by PAY, when the stock was trading around $25 even though the buyout had been announced at $29. Or the other day when ASPV dropped 12% because they had missed analyst expectations. But they affirmed their yearly guidance of 20-25% growth this year! Either the market doesn't believe the company, or it doesn't take this kind of growth into account in pricing ASPV. Either way, Mr. Market is a nutbar, and cheap stocks are out there to be bought.

PS - As of yesterday, my biotech portfolio was up 1.93%, but underperforming the biotech market. On the other hand, both my MFI and HG portfolios were up 13.1%, outperforming the general market by several percent. Sweet!

PPS - I've discussed CBST a bunch. My fingers are crossed for their earnings announcement tomorrow.