Focus On The Big Picture When Studying Fundamentals

Fear is almost always overstated. If you are dealing with a stock that has excellent financials over a 10 year period, then any steep decline in the stock could definitely end up being a buying opportunity. Sentiment usually reaches bearish extreme levels if the respective company’s shares pull back convincingly. However here is where the investor has to concentrate on the big picture and study how the stock has performed over the last decade to get a feel for where the company’s financials will be in a few years time. Just remember this. Any time you see excessive bearish commentary on a proven company, there may be an attractive set-up brewing. Sentiment is always at bearish extremes when a stock is hated but that is the very point at which an investor should be looking to go long if the fundamentals stack up. “Buy when other are fearful and sell when others are greedy” is definitely a key investor’s motto I agree with. Unfortunately the majority of investors do the opposite as they let their emotions drive their decisions. We do not want to be in this camp.

Whether it be a poor guidance number, a poor earnings report or an accounting issue, stocks can sell off convincingly on a temporary basis which may present opportunity. Two opportunities over the last while that come to mind are Disney (NYSE:DIS) and Apple (NASDAQ:AAPL). Disney stock dropped to close to $90 in October 2016 from the $120 level 10 months earlier. The main reason was that the company’s ESPN subscriptions (which make up the lion’s share of the top line) were declining at a rate of knots every quarter and the market didn’t like it one bit. Now remember that Disney (although being highly dependent on ESPN revenues) has strong proven competitive advantages. Its branded businesses along with its media division have shown strong pricing power over the past decade. We can see this trend in both its gross margins and operating margins which have increased substantially over the past 10 years. In fact, all of its major financial metrics (including free cash flow, earnings, revenues and dividends) have been growing strongly so value investors decided to step in when the stock dropped to around that $90 level. Although Disney was definitely helped by the tailwind of a rising stock market (NYSE:SPX), the stock rallied aggressively off those lows once value investors decided to enter on mass.

I also vividly remember Apple suffering the same fate in May of 2016 when the stock also dropped to around $90 a share. Here articles were being circulated on mass that iPhone growth was finished as users were holding on to their phones much longer nowadays compared to previous times. Sentiment dropped sharply as many investors believed Apple had turned from being a growth stock into a value stock. However the strong competitive advantage Apple has in my opinion is its customer switching costs. The company works relentlessly every year to tie-in its customers more and more into its eco-system of products. There are millions of die-hard Apple users out there who will never jump ship. Again value investors stepped in at that point and the rest is history.

The underlying theme in these examples is that it is quite normal for a behemoth to report declining earnings or/and sales from time to time. The trick however is to be able to decipher whether the new negative growth trend is only a temporary phenomenon or something permanent. Always study the fundamentals especially over a longer time frame that simply one or two years. In Disney’s case its ESPN numbers were tanking the stock every quarter as the market was associating its media performance with the company in general. Bearish commentary was stating that cable was dead and Disney would find it difficult to adapt to streaming its product over the internet. At the end of the day, the fundamentals didn’t change. As long as ESPN keep buying the rights to the content over time, you feel that it will still be able to get its content to its customers.

Apple has always produced quality so when management reported declining sales, the market tanked the stock accordingly. However fear is always overstated and again bearish investors took too much of a short term view. In fact, Apple probably wont take out its 2015 top line numbers until 2018 but yet again, the trend of its growing financials should continue. Given the sheer force at which Apple’s earnings, free cash flow and revenues have risen over the past decade, many bulls would say that the stock is still cheap at its present valuation (Earnings multiple of 16 on the 03/16/2017). However the easy money has been made and it was done so when there was doubt whether the company could continue to keep its surging momentum going. Look for these turning points. In Chinese the word “crisis” also means opportunity. Train yourself to really get clued in when stocks are trading at extremes as this is where the real long opportunities exist in the market.

 

 

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