How to Avoid the “Turnaround Trap” This Earnings Season
We’re just a few days into earnings season, meaning there’s a flood of sales, profit, growth and cash-flow numbers cascading our way.
On all sorts of companies. In all sorts of industries.
And it’s not just numbers … it’s also “spin” – as execs shift into “what comes next” mode for their companies in the last half of the year.
Tomorrow, 35 companies report earnings. The next day, there’ll be 64 of them. And by next week, we’ll be getting anywhere from 100 to 400 earnings reports per day – for the next four weeks.
I expect earnings will be good. Not for everyone. But for tech, industrials, and discretionary – which have all been growing, delivering sales-and-profit surges quarter after quarter.
Investment-banking heavyweight Goldman Sachs doesn’t share my optimism. At least, not in the public research note it released last week:
“Revenues are expected to post no year [over] year growth for the first time in 10 quarters,” the Goldman analysts wrote. “Where we do see profit margins rise, it’ll mostly be from companies charging higher prices while their input costs aren’t inflating as much.
MarketWatch put a finer point on it with this headline:
“This earnings season, expect companies to keep margins high the usual way, by firing people.”
Translation: Companies aren’t seeing business growth, so they’re playing the usual games to get profit or margin growth.
So, what do you do with all this?
Well, when the headlines get this pessimistic, there are two approaches you can take with your stocks…
- “Great! When other people dump stocks on bad news, I can swoop in and buy at a discount. Surely, I’ll make tons of money when the stock bounces back later.”
- “Yeah, Goldman, not sure I see things your way. There are plenty of companies whose fundamentals are in great shape. And I’m going to bet on those.”
Me? I’m in the second camp.
And with good cause.
In an earnings season where there’s so much uncertainty, there’s also lots of risk.
It’s more important than ever to stick with the very best companies. Those are companies whose stocks will rebound when investors realize that they’re undervalued (i.e. “cheap”).
But a rebound is very different from a turnaround – where you’re betting on a company with sketchy financials, hoping the execs of that firm will finally figure things out and customers will come around.
That’s a risky move to take… especially as we navigate this avalanche of earnings.
In fact, I’d actually label this approach as the “turnaround trap.”
And here in today’s Power Trends, I’m going to show you why.
Why I Avoid Turnaround Trades
The belief that an unloved company is poised for “the comeback of the year” can be very seductive.
But where most other folks see a turnaround in the making, I see a dumpster fire. It may just keep burning until everything turns to ash… and, you know, it stinks.
So, when I look into a company and find that sales and profits are shrinking – and see that it’s taking on debt to make ends meet – I’m flat out not interested.
I’d rather buy when a company ticks all the boxes for financial strength on the fundamental side – and when its shares are a magnet for money from big institutional players.
In fact, there are 29 factors I consider when creating my overall Quantum Score grade for a stock.
My strategy combines fundamental, technical and money-flow components – and is a lot like the classic “CAN SLIM” method created by Bill O’Neill, the stockbroker who founded Investor’s Business Daily back in the ‘80s. (Except that I have a much more powerful computer I can use to run my statistical analysis on more than 6,000 stocks every day.)
As a reminder, CAN SLIM stands for:
- Current quarterly earnings growth
- Annual earnings growth
- New product/service, management, or price high
- Supply and demand (accumulation on heavy volume)
- Leadership in its industry
- Institutional ownership of the stock
- Market direction: Is the stock in sync with the broader trend?
With apologies to Stephen Covey, you can also think of them as the “seven habits of highly effective stocks,” because these are “clues” that tell you a stock is about to embark on a big run.
In Bill O’Neill’s day, it was Texas Instruments (TXN) and Microsoft (MSFT) that lined them up just right for huge gains. To see the type of stocks I’m finding today with my fundamental and technical analysis, watch this.
A stock can surge without hitting all these marks – underdogs do occasionally win, of course. But these tend to be longshot bets – and their rallies can flame out just as quickly as they started.
If you’re even a tiny bit late to the game, you’ll probably miss most of the gains. That’s the challenge investors faced with “turnaround” meme stocks like GameStop (GME) and AMC Entertainment (AMC) back in 2021:
You had to time your entry and exit exactly right (or have access to a time machine) to actually make money on these stocks.
So, I stick with what works for the true “smart money” players: the Big Money investors who work to keep their moves secret, and who I was able to track during my time as the head of a major Wall Street trading desk.
I look for one- and three-year sales-and-earnings growth.
I look for double-digit profit margins. Slim margins don’t cut it for me. There are plenty of other fish in the sea that do meet my criteria.
And even if the company is making a bunch of money, I study the debt load to make sure it’s not overleveraged.
Bottom line: I follow the money flows – but I won’t follow them into a roach motel.
I’m not interested in the turnaround story unless (and until) sales and earnings show that company is already making money.
Then I wait for the stock to hit my Quantum Edge “buy zone.”
Once that happens, I’ve got at least a 70% chance of making money. And, over time, by sticking with the high-quality stocks that Big Money pros are buying, my strategy beats the market 7 to 1.
And since I launched Quantum Edge Pro, we’re sitting on nine winners with average gains of 21% in our first nine months. Our five other stocks are down a mere 6.5% on average.
Many of these top-ranked stocks are still in the buy zone now. If you’d like the details – including the new buy recommendations I’ve started making – click here to learn more.
Talk soon,
Editor,
Jason Bodner’s Power Trends