CWS Market Review – April 6, 2012

On Thursday, the stock market finished the fifteenth day in a row of its “up, up, down, down, down” pattern. Why is this happening? Honestly, I have no idea and it’s safe to say that even trying to find a reason will only lead us to being fooled by randomness. But as I said last week, the stock market is most likely entering a trading range until we have a better handle on how the jobs market and earnings outlook shake out.

In this week’s issue of CWS Market Review, I want to highlight some of our most promising upcoming earnings reports. I’ll also explain why assets are suddenly disentangling. If you want to sound smart, you can say the correlations are declining, but between you and me, this simply means that the normal order is reasserting itself—and that’s a very good omen for our Buy List.

Bed Bath & Beyond Soars on Blow-Out Earnings

Before we get to that, let’s talk about our star pupil of the week: Bed Bath & Beyond ($BBBY). The stock soared 8.5% on Thursday after a blowout earnings report. BBBY is a wonderful company and it’s in a great position to prosper from renewed consumer spending.

After the closing bell on Wednesday, Bed Bath & Beyond said it netted $1.48 per share for its fiscal fourth quarter. That creamed Wall Street’s consensus by 15 cents per share. Not too shabby. In December, the company told us to expect Q4 earnings to range between $1.28 and $1.33 per share. So their results were even better than they expected.

Looking through the numbers, the details were exceptionally strong. Profits jumped 32% from the fourth quarter of 2010. Quarterly sales rose by 9.1% and the key retailing metric, comparable store sales, rose by 6.8%. For the year, Bed Bath & Beyond earned $4.06 per share which was also a 32% increase over the year before. Sales rose 8.5% to $9.5 billion, and comparable store sales increased by 5.9%.

I’ve discussed before how growing margins have aided corporate profits, but the effect has been especially pronounced at Bed Bath & Beyond. This is the twelfth quarter in a row in which the company has expanded its net margins. In the three years since fiscal 2009, total sales have grown by 32%, but net earnings are up by an amazing 133%. The reason is that net profit margins increased from 5.9% in 2009 to 10.4% last year.

Even with as good as the numbers are, I was especially impressed by Bed Bath & Beyond’s guidance. For Q1, BBBY sees earnings ranging between 79 cents and 83 cents per share. They earned 72 cents per share in last year’s Q1. For the full-year figure, they project earnings “to increase by a high single to a low double digit percentage range.” If we take that mean to 10%, it translates to a full-year forecast of $4.47 per share.

This is excellent news. We now have a 24% year-to-date gain and that comes on top of a nice 18% gain we racked up last year. BBBY continues to exceed expectations. I said in December that I thought the Street’s forecast for 2012 of $4.39 was too high. Shows what I know! Plus, I urged investors to be cautious about this stock going into earnings. Now we have solid evidence of how well things are going. In fact, I suspect that the company is low-balling us with this latest guidance. We have a winner on our hands. I’m raising my buy price on BBBY to $75 per share.

The Stock Market’s Return to Normalcy

During most of last year, the stock market was jerked around by an annoying tug-of-war between risk-on and risk-off trades. The U.S. stock market became highly correlated with the dollar/euro trade, and that was tied to the latest political rumors in Europe. Not only were stocks correlated with currencies, but also stocks were highly correlated with each other.

When this happens, it’s very frustrating for our investing style which focuses on high-quality stocks. I prefer to see a lot of dispersion among stocks (meaning everybody doing their own thing). Last year, it seemed like every stock behaved like every other stock. One odd offshoot of this effect is that the handful of stocks that didn’t follow the crowd saw highly abnormal activity. Netflix ($NFLX) was probably the best example. The company soared to an absurd valuation simply because it was one of the very few ideas that seemed to be working. Not surprisingly, the stock has plunged back to earth over the past several months.

The financial media often reported that most actively managed mutual funds underperformed the broader indexes last year. That’s true, but it missed an important fact: The relative performance of active managers is highly correlated to the relative performance of small-cap stocks.

This makes perfect sense since the index funds dominate the mega-cap stocks. With the rising level of fear last year, investors flocked to larger (and hopefully) safer names. Now we’re learning that some of those big-name stocks may not be so safe. Blue chips like ExxonMobil ($XOM) have badly lagged the market this year.

Fortunately, the U.S. stock market has slowly untangled itself from the ups and downs of Europe. As bad as the events in Greece are, they’re very small within the realm of global finance. One outcome of the market’s return to normalcy is that daily volatility has declined dramatically. This year, volatility has had its biggest decline in 78 years.

The WSJ recently noted that stock correlations are at their lowest level since before the financial crisis. I view this as a very positive development for us, and investors will soon realize that there will be a very large gap between good stocks and bad stocks.

Look for Good Earnings from Ford

Earnings season begins next week and I’m already going through my preparations. Outside of our Buy List, I’m not especially optimistic for the results this time around. One company that I think has a very good chance of surprising investors is Ford ($F). Wall Street currently expects earnings of 38 cents per share, which seems very low to me.

The news at Ford continues to get better. In my humble opinion, the company has a very good shot of earning $1.50 per share for this year, which means the stock is going for a little over eight times earnings. That’s a very good bargain. I was pleased to see Ford report its best March sales in five years. Plus, a major analyst recently raised his earnings estimate for the automaker. Ford is also ramping up production in China. The stock is a very good buy up to $15 per share.

Another earnings report to keep an eye on is CA Technologies ($CA). Three months ago, the company stunned Wall Street by beating earnings estimates by more than 20%. CA also raised its dividend five-fold. Look for more good results in a few weeks. Some other earnings surprises to watch for are from Wright Express ($WXS), JPMorgan Chase ($JPM) and Moog ($MOG-A). As I said, the market may be choppy over the next few weeks, so please don’t get discouraged. The trends are definitely in our favor.

That’s all for now. Remember that the market will be closed on Good Friday. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy

Posted by on April 6th, 2012 at 6:50 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.