Apples and Oranges, Stocks and Companies
Peak Perception = Market Top
Oasis Petroleum (OAS)
Every day, we’re told the market moved up because of this economic report, or down because of pessimism surrounding upcoming earnings, or sideways because investors were waiting on some upcoming news. We’ve seen that this week following the election results, with many believing the stock market will XYZABC because of XYZABC.
In other words, the media gives you the impression that the market (and, hence, individual stocks) are directly responding to specific news, such as earnings, economic data, politics or international affairs.
But that’s totally wrong!
I don’t mean to suggest that the market is a totally isolated animal; over the long run, the market tends to follow along the general path of the economy and earnings. But for periods of months—even years, both the market and individual stock trends can be affected by factors that are more powerful than earnings or the economy. For example, just look at this monthly chart of Abbott Laboratories (ABT), a conservative blue chip growth stock:
The bars represent the stock itself, while the generally smoothly rising line is the earnings line (depicting the company’s 12-month earnings per share totals). As you can see, back in the late 1990s, ABT was trading around 50 per share, even as earnings totaled about $1.60. Now fast forward to mid-2011, and you see ABT was still hovering at 50 per share ... even though earnings by then were up to $4.50 per share! Of course, we’ve seen the same thing across the market for more than a decade—no net progress for stocks, even as earnings and dividends have kited higher, and interest rates have plunged (generally making stocks more attractive).
How can this be? Simple—the stock is not the company. It’s a topic I’ve written about many times, but it’s so easy to forget, especially nowadays when the market is so news-driven. For management and employees at many firms, things are better now than they were 10 or 12 years ago. But for shareholders, not much has changed.
So what does drive share prices? Investor perception—how investors (particularly big investors, like mutual funds and pension funds) view the company’s future prospects. Simply put, when big investors sour on a firm’s potential ... when they feel the best of the firm’s growth is in the past ... they usually sell. And when they sell, the stock goes down! (Note, too, that funds don’t have to dump all of their position to top a stock; they might cut back from 7 million shares to 3 million shares, but that still represents a ton of selling.)
My point is that too many investors confuse the stock and the company. After a stock takes a hit, I often get questions like “Is the company still doing OK?” or “Why is the stock down so much if earnings met expectations? The answer lies in perception. While fundamentals like sales and earnings growth are important, they’re not everything. But to really know when a stock is putting in a meaningful top, you have to measure investor perception; the fundamentals will always turn down months after a stock does.
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The above discussion is relevant today because of what I’m seeing among many high-profile companies that have been huge winners during the past few years, names like Priceline.com, Chipotle Mexican Grill, Baidu and even Apple. Are these firms still doing well? Absolutely! All of them have reported third quarter results, and as a group saw their revenues grow 29% from the year before, while earnings were up 32%.
But each of their stocks has run into trouble; I think at least a couple have probably hit long-lasting tops, and even the others look ragged.
Baidu, which was probably our biggest winning stock of this post-2009 cycle, hit a price peak back in July 2011; since then, the stock is more than 30% off that high and its relative performance looks awful. There are fears of greater competition.
Chipotle Mexican Grill topped in April of this year and managed to collapse 40% in just a few months before its recent bounce.
It’s the same story with Priceline, which fell 30% after topping in April. Shares have popped back somewhat on earnings but have a mountain of resistance to overcome in the 650-700 area.
And, finally, Apple just hit a peak in September but has slipped about 20% from its high (as of last week), falling below its long-term 200-day moving average for the first time since June 2011.
Now, it’s always possible one or two of these names will come back in a new market uptrend (though I wouldn’t touch any of them here unless you’re a very nimble trader). But my point is that, even though these companies are still doing well, investor perception appears to have peaked ... and if that’s the case, it’s going to be hard to make all that much money in the stocks.
The bottom line is that when you click that buy button on your online brokerage page to buy, you’re not buying the entire company, its operations and its products. No, you’re buying a stock—something that is driven mostly by supply and demand, which in turn is driven by emotions, dreams and desires.
Just something to keep in mind as we all try to interpret this volatile market action.
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Now back to some real analysis. The market remains in a correction—by our measures, the intermediate-term trend turned down a couple of weeks ago, and the rallies of late have been unimpressive, with most lacking any volume or real upside thrust.
There are plenty of parts of the market that don’t look great ... growth stocks in particular. Many have been hit on earnings, and it seems like anything with a very high valuation is being taken down. Of course, some names are still holding up, but usually they are less well-known names that haven’t been outstanding performers for the past few years—the stocks like Apple and Chipotle that went up 500% are under pressure, while those that have consolidated for a year or two are still consolidating.
However, I do see some encouraging signs. One is that this correction, which is now nearly seven weeks old, has been relatively mild pricewise. Sure, maybe that’s changing post-election, but at this point, it’s a small change of character from the past couple of years, when the major indexes have whipped up and down repeatedly.
Second is the fact that financial and emerging market stocks, two sectors that have led pretty much every downturn since 2010, are actually holding up well since the market’s mid-September top; both have etched flat bases and have hit slightly higher lows as the major indexes have done the opposite.
And third is that, despite falling prices for actual commodities (the price of oil is down 14% since mid-September, copper is down 10% during that same time, and natural gas has dropped 10% during the past two weeks), commodity stocks have been reacting well to their quarterly reports, with some actually punching to new highs.
Thus, while I’m still looking for big growth ideas, I’m not being closed-minded about where I find them. In today’s Wealth Advisory, I want to give you an idea from the energy patch, with what I believe is one of the most attractive fundamental stories in the rapidly-growing Bakken, specifically an area known as the Williston Basin, where much of the action is occurring.
Oasis Petroleum (OAS) has rights to drill in more than 300,000 acres in the Williston Basin, and it’s doing just that with an extremely aggressive drilling program (operating nine to 10 rigs) that is driving production through the roof! Production for the just-reported third quarter totaled 24.2 million barrels of oil equivalent, up 109% from a year ago and up 19% from the prior quarter! And management sees more of that, with fourth-quarter production in the 26 to 28 million-barrel-range, up about 78% from a year ago.
But there’s more to the story than that. We’re very impressed that Oasis is rapidly building up its infrastructure and capabilities, both to maximize how much oil it can sell, and also to cut costs. For instance, the firm has established an Oasis Well Services division, which has its own fracking and hydraulic pumping crews, and does its own salt water disposal; these efforts have helped drive down well costs by 10% this year, with another 5% to 10% reduction coming in 2013.
Finally, Oasis has found a bunch more natural gas in its wells, and while gas is still a small part of its pie (8% to 10% of production), it’s growing, so its gas infrastructure has ramped up as well. All told, revenues and cash flows have grown at triple-digit rates for many quarters; that could slow as the firm grows larger but I expect years of big production growth.
So that’s the company—but what about the stock? Well, I think perception (there’s that word again) of the firm’s potential might be getting close to an inflection point. OAS came public in June 2010 and rallied nicely into March 2011 ... but it’s been building a huge base ever since! Recently, though, the stock has tightened up in the 28 to 32 area; it’s tempting to nibble here, but the real fireworks should begin if/when the stock breaks out above 36.
All the best,
Editor of Cabot Market Letter