A disquieting analysis by Michael Brush: could explain the slow recovery of Adaptec. Or maybe Adaptec fits the criteria of the faster recovering stocks coming up in part 2 of th report
When good stocks go bad
Stocks that sell off on bad earnings news may seem like bargains.
But be careful. Chances are, they will take longer than you think
to recover.
First in a two-part report
By Michael Brush moneydaily.com
As we move into the peak earnings confession and reporting season
over the next six weeks, investors will be facing a common
temptation.
This is the time when the management behind many a high flying
momentum stock will fess up to having a weak quarter, causing
shares in their companies to lose as much as half their value in
the blink of an eye.
Surely the panic selling that occurs as the momentum investors
flee a stock must create a good buying opportunity. After all, the
same management that turned in the great performance is still in
place. Just stick out a rough quarter or two at most, and these
stocks will be back up near where they were in no time, right?
Probably not.
Chances are, momentum stocks that tank because they preannounce a
shortfall or report lower-than-expected earnings will underperform
for at least a year, according to a study by Claudia Mott, a
small-cap stock analyst at Prudential Securities.
Trolling the momentum trash, as she puts it, simply does not work
that well. "Some investors think: 'We missed the stock the first
time around, so this is a great buying opportunity'," explains
Mott. "Well, here is proof that it is not. When it comes to these
momentum names, these blowups don't turn out to be buying
opportunities."
Portfolio managers who use momentum strategies, which try to come
up with stocks that have things like rapidly expanding profit
margins or steadily improving earnings forecasts, agree with
Mott's findings. Once these stocks get hit, they bounce along the
bottom for some time," says Louis Navellier, of Navellier &
Associates. "The big-cap stocks can bounce back a lot quicker. But
the small ones can take as much as two years to recover."
In her study, Mott screened for momentum stocks that had moved up
quickly and then got hammered - either because their earnings
estimates were revised downward, or they reported weaker than
expected earnings. Then she looked at how long it took them to
recover. The results: overall, fewer than half outperformed their
benchmark indexes after a year.
The least likely to bounce back were mid-cap stocks that got hit
because of downward earnings revisions. Only 21% to 26% of these
stocks outperformed their benchmark, the S&P MidCap Index, after a
year. The ones that seem likely to do the best are small-cap
stocks that sank because they missed earnings estimates. After a
year, between 40% and 43% of them outperformed their benchmark,
the Russell 2000.
"Some people think that because more money is being invested these
days using momentum strategies, stocks deserve a rebound if they
get extremely beaten up when they are sold haphazardly by momentum
players," says Mott. "But just because more money moves out when
momentum players pull the trigger, it doesn't mean the performance
after a negative surprise is any better."
Still, not all momentum stocks that thank on bad earnings news
will be in the penalty box for the long haul. In Tuesday's Money
Daily, we discuss how to identify those that have a better chance
of bouncing back quickly.
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