3 dumb downgrades to ply for profits
Watch for a chance to grab shares at a great price amid the Wall Street ratings game.
By Jamie Dlugosch
This week, Cleveland Research reduced profit and revenue estimates for Whirlpool (WHR) and the stock dropped some 8% on the news.
Are people that stupid or what?
Whirlpool is a rock-solid stock with a cheap valuation. The company participates in an industry that is rebounding significantly and will likely continue to do so as the global economy expands.
The basis for the Cleveland Research move was, by their counts, a weak sales effort over the last 30 days. The kicker though is that the weaker sales are likely to have no impact on the company's per-share earnings.
OK, whatever. I’ll wait for Whirlpool to provide guidance for the future when it reports earnings for the September-ending quarter on Tuesday. When the report comes, the odds favor an earnings beat and a quick rebound in share price. Take the discount and run to the bank for a quick short-term trade thanks to another random Wall Street downgrade.
Every day Wall Street is offering some sort of downgrade. In my estimation, the moves are there simply to generate trading commissions. They also offer opportunities to scoop up shares on the cheap. Here are three downgrades you should exploit for quick gains in your portfolio:
Arris Enterprises (ARRS)
There are times when Wall Street changes a rating on a stock in a very short period of time. That's the case with Arris Enterprises. Zacks Investment Research upgraded the stock to "outperform" in mid-September. At that time Zacks noted the possibilities with respect to the company’s cable set top product via acquisition from Motorola Mobility.
As if on cue, a month later Zacks was back out with a downgrade of Arris to "neutral." Do these guys even read their own work? This time the downgrade was based on valuation. Funny, but the share price on the day of the downgrade was pretty much the same price of the stock on the date of the upgrade.
I call baloney on this one. Arris shares are cheap relative to expected growth and the stock shows up highly on my own stock rating system using the P/E Gap -- the difference between a stock's price-to-earnings ratio and its expected profit growth rate. The wider the gap, the better the opportunity, and in the case of Arris the gap is wide. I’d ignore Zacks and own this stock.
Wall Street firm HSBC downgraded shares of Schlumberger, taking the stock down to "neutral" from "overweight." With the stock up some 30% since the beginning of July, the downgrade makes sense on the surface. The suggestion seems to be to lock in some profits. If that’s the case, it is hard to argue with the downgrade. The trouble I have is based on valuation. Analysts expect Schlumberger to grow profits by 20% in 2014. That’s a very healthy clip and with the stock trading for only 15 times earnings there is still room to run here.
There is an interesting tapestry to the Wall Street ratings game. Just a few days before the HSBC downgrade, RBC Capital is out with a report suggesting that Schlumberger third-quarter earnings are likely to be better than expected. Typically earnings beats are greeted with a nice pop in share price. That alone is reason to ignore the HSBC downgrade and let this one continue its ascent.
What is the point of downgrading a stock in the immediate aftermath of a company pronouncement that has sent the stock down some 25%? It is such a move that brings much scorn to the whole Wall Street ratings game.
In early October, K12 shocked the market by reducing guidance thanks to weaker-than-expected enrollment. Shares of K12 sank 25% on the news. Wall Street downgrades were fast and furious in the wake of the announcement. Both BMO Capital and Robert Baird cut their ratings on the stock, lowering their target prices.
What a joke. Perhaps you might want to tell your customers about a downgrade before the stock goes down 25%. A day or two later the one Wall Street rating that made sense was a Wells Fargo upgrade of the stock. Now you’re talking.
I want to own a stock when it crashes like this and you should too. Despite the downgrade, this company has amazing growth potential. Don’t be surprised to see 20% profit growth in the near future. Typically such growth stories trade for premium valuations, but that is not the case here. I’d be an owner of this stock and ignore the ratings downgrades.
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