24 stocks that could fall after profits
The second quarter earnings season kicked off this week with the big banks in the lead. But even with a booming economy and many stocks at or near record highs, there are still risks lurking for investors.
One such risk is profit explosion (when a stock drops significantly the day after it is declared). Shares of electric vehicle pioneer Tesla (ticker: TSLA), for example, fell about 4.5% after reporting better-than-expected first-quarter profits in April. The problem, however, was that the profits were in part due to a one-time gain on the company’s Bitcoin position.
To avoid these situations, investors may want to avoid companies with below average earnings quality, or earnings that are boosted by factors other than improving the core business.
Companies with relatively low earnings quality metrics are not necessarily trying to fool anyone. But earnings reporting is only about expectations, and poor earnings quality can be a warning sign.
Chris Senyek, accounting and tax policy expert at Wolfe Research, ranks companies from 0 to 100 based on the quality of their earnings and compares companies within industries against each other. A low income score can be due to a combination of factors. Often, non-cash fees, which include one-time earnings, don’t repeat themselves, skewing the digits by a quarter. Increasing levels of working capital, which includes items such as inventory, can mean that earnings and cash flow are unrelated. Other accounting factors, including lower than expected tax rates and one-off adjustments, may contribute to a lower quality score.
Senyek examines many other factors to generate his scores. He recently identified 10 companies that have experienced a change of CFO or recent mergers and acquisitions, which can generate unexpected earnings volatility and score low on earnings quality compared to their peers.
His list of 10 stocks to avoid this quarter includes the installation contractor
Construction products installed
(IBP), manufacturer of contact lenses
(COO), healthcare company
(PINC), defense supplier
(EFX), manufacturer of industrial components
(RNX), software provider
(XRX), T-Mobile US (TMUS) and
Senyek also recommends that investors avoid companies with low earnings quality and high short interest, or the amount of stocks borrowed and sold short by bearish investors betting on price drops relative to the total amount of the total. shares available for trading. This is because bearish investors expect something bad to happen with the stock and earnings are usually the catalyst.
Large stocks that meet its criteria for lower earnings quality and higher short interest relative to a company’s peer group are
Network of dishes
(LYFT), software provider
(RNG) and home decking company
The average short-term interest of this group is around 11%. That’s about five times the average short-term interest for
While there is no guarantee that stocks will go down when these companies report earnings, Senyek believes the risk of a profit explosion is high. Investors may want to look beyond the overall earnings numbers with these two dozen stocks.
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