Some Really Bad, No-Good, Awful Advice

Back in early July, I penned an article about six stocks that could double within the next two months. My reasoning in selecting the stocks was broken down into two simple premises:

  1. In business, innovation always wins out.
  2. Heavily shorted stocks can jump on any sign of good news.

So I went out looking for highly innovative but heavily shorted stocks with histories of beating earnings. Two months later, the results are in:

Dismal!
Take a look below to see how my six selected stocks did. Because all of these companies reported earnings over the past two months, I show how they performed against analyst estimates, as well as what their average beat had been prior to the latest earnings release.
 

Company

Change Since July 1

Earnings Results

Average Beat Prior to This Quarter

Entropic (Nasdaq: ENTR  ) (47%) Miss by 5.5% 27%
Travelzoo (Nasdaq: TZOO  ) (42%) Miss by 22% 167%*
SodaStream (Nasdaq: SODA  ) (40%) Beat by 33% 119%
First Solar (Nasdaq: FSLR  ) (23%) Miss by 24% 36%
Coinstar (Nasdaq: CSTR  ) (14%) Beat by 5% 46%
Ebix (Nasdaq: EBIX  ) (13%) Beat by 43% 18%

Source: Google Finance, E*TRADE. 
*Excluding a one-time charge to the state of Delaware in the first quarter.

Though it's important to remember that over the same time period, the Dow Jones Industrial Average (INDEX: ^DJI) was down more than 6%, these results are awful. Instead of doubling, half of the stocks almost did the opposite: They saw their value cut in half!

Where I went wrong
I would like to think that my biggest mistake was not in the argument I laid out. I still believe that highly innovative companies win out in the long run, and that heavy shorting could provide a turbo-boost to their stock price.

Instead, I think mine was an error of omission. First of all, the "long run" is measured in years and decades, not two months. Furthermore, stocks that are heavily shorted are just as likely to take a dive on the sign of bad news as they are to spike on word of good news. I didn't give that possibility enough space in my argument.

Throw on top of that the poor returns and volatility from the larger market over these two months, and I created a recipe for disaster.

Earnings misses
When a company is heavily shorted, or when it has a high P/E, it can't afford to come up short of analyst estimates. But that's exactly what happened with Entropic, Travelzoo, and First Solar.

For Entropic, this owed to weak demand from their largest customer, Verizon; Travelzoo was busy building out its Local Deals network, but the quarter ended before that spending could translate into revenue; and First Solar is still dealing with much weaker demand in Europe than in years past.

Modest beats, but unfavorable guidance
Both Coinstar and SodaStream beat analyst estimates, yet they were still punished by the market in the ensuing weeks. 

Coinstar had to deal with a double-whammy: The president of its Redbox segment announced his resignation in July, and the company reduced revenue guidance for the second quarter before earnings were announced.

For SodaStream, share prices fell off a 40% cliff after not changing their full-year guidance even with a 33% beat. That signaled to investors that management wasn't expecting anywhere near the growth that the market was pricing in.

Why no pop here?
This leaves us with the curious case of Ebix. The insurance software provider beat estimates by a whopping 43%, yet still suffered from the slings and arrows of the market.

The company has been hit in the past by accusations of growth purely via acquisition, as well as by the actions of their admittedly eccentric CEO, Robin Raina. The Fool conducted an interview with Raina recently, and the conversation had some Fool analysts salivating for Ebix shares.

Lesson learned
So I leave this two-month experiment a little poorer, but hopefully wiser. I bought shares of Travelzoo before the drop, but I am still confident in its business and continue to hold the shares. The importance of a years-long investing horizon has been powerfully reinforced, and I still think there are deals to be found among these stocks. Now, however, I'll tread even more carefully among the heavily shorted ranks.

If you'd like more ideas for investing your hard-earned cash, I'm willing to offer you a special free report: "The Only Stock You Need To Profit From the NEW Technology Revolution." Inside, you'll find out about another innovative company with a breakthrough technology that is changing the face of business. It's yours today, absolutely free!

Fool contributor Brian Stoffel believes that learning from mistakes is the most important thing any investor can do. He owns shares of Travelzoo and SodaStream. The Motley Fool owns shares of Ebix. Motley Fool newsletter services have recommended buying shares of SodaStream International, Green Mountain Coffee Roasters, First Solar, Ebix, and Travelzoo, creating a lurking gator position in Green Mountain Coffee Roasters and shorting Green Mountain Coffee Roasters. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (15) | Recommend This Article (27)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 02, 2011, at 4:23 PM, emferguson wrote:

    Don't defy the shorts. If a stock is heavily shorted, I won't touch it. It's the one sign above all others I rely on. I figure shorts take such a serious risk that they probably did their research pretty carefully, and it seems they're right far more often than they're wrong.

  • Report this Comment On September 02, 2011, at 4:35 PM, TMFCheesehead wrote:

    @emgerguson-

    Though I don't think this is an iron-clad rule, it's worth considering, especially if you have a short-term focus. Clearly, I learned the hard way.

    Brian Stoffel

  • Report this Comment On September 02, 2011, at 4:43 PM, EnigmaDude wrote:

    I think you simply need to adjust your time frame. Check back again in 6 months and see how these stocks fare. Your thesis is good, just bad timing.

  • Report this Comment On September 02, 2011, at 5:09 PM, TMFCheesehead wrote:

    @EnigmaDude-

    Let's hope so. I'm thinking more like 12 months from now...

    Brian Stoffel

  • Report this Comment On September 03, 2011, at 12:04 AM, jimmy4040 wrote:

    I give you props for bringing this up. What you and some of the other MF writers don't want to acknowledge is that the day of the individual stock picker in a bad market is closing down. You have two of the absolute best I have ever seen, but with high frequency and program trading, the opportunities to outperform in a down market are very very small.

    In an up market, growth will alwas outperform of course.

  • Report this Comment On September 04, 2011, at 4:48 AM, fiduke27 wrote:

    Heavily shorted stocks can often explode upwards on the right news. like emferguson wrote "I figure shorts take such a serious risk that they probably did their research pretty carefully, and it seems they're right far more often than they're wrong." which is true. But lets say the shorts are shorting because there is wide agreement that a flagship product will fail, but the product turns out to be freaking awesome. In that case not only will 80% of the shorts cover, momentum chasers will dive on, as will short and medium term traders while the long term guys who have been holding on for months or years get handsomely rewarded.

    I agree with the author that all of these stocks will probably double, but you need to be looking years down the road, I think 12 months is too short a time.

  • Report this Comment On September 05, 2011, at 11:18 AM, BindingSuccess wrote:

    Since August 30th 3 law firms have either started investigating or have file suit against Travelzoo or it's directors. Take a look at the buying selling that took place between Mar - Jun 2011 and note the buy sell ratio is 4.75:0.The majority of the sellers were Azzurro capital and Ralph Bartel which, for all intents and purposes are the same person. They are in empire building mode ever since Travelzoo sold the APAC division to Azzurro. The recipe in theory appears to be: First and foremost - go on a buying spree of company T's shares at least one year prior to selling your losing divisions.(note: this is not the first round of pump and dump that you've completed - see prior years for explicit examples)... 1) pull parts of a company that are losing business (company 'T' for example) out of your front pocket and place in your back pocket with another company (company 'A' for example), 2) wait for company for T's shares to rebound as a result (use 10q as a guide - but essentially about 12-18 months later) of the 'suddenly' profitable company you should large mutual funds jumping in at the tail end of this climb (think: elephant in the bathtub). 3) Before the 'elephants' come to bathe being execising options then commence with a 'sell' abration once the water starts to spill from the tub. Serves 1 directly and possibly others who know the recipe. Repeat as necessary.

    PS - I do not own any TZOO stock. Not now, not in the past, and not in the future.

  • Report this Comment On September 05, 2011, at 11:25 AM, TMFCheesehead wrote:

    @BindingSuccess-

    Though I don't have access to any info which can prove my theory, I would have to disagree that this is a pump and dump.

    The reason for the APAC spinoff, as I understand it, has more to do with taxes than anything else. Because TZOO is incorporated in the US, but was losing money hand over fist as they set up shop in Asia, they were losing tons of money, but weren't allowed to count that as a loss for tax purposes, which only exacerbated the problem. The company has in place a mechanism to buy back the APAC division between now and 2016 (I believe).

    And while I too was a little distraught over the Bartel/Azzurro selling, he still owns 51% of the company and was just reducing his position from the monstrous 64% it was at before.

    Time will tell how this all pans out.

    Brian Stoffel

  • Report this Comment On September 05, 2011, at 3:39 PM, TCNFool wrote:

    Brian, I think it is good that authors follow up and analyze the result of their stock picks. Thank you for doing so. That being said, what you wrote in the first place was pretty irresponsible and a huge gamble rather than sage advice or an interesting (and perhaps a profitable) observation. Readers on MF are looking for ideas and education and certainly all don't have the time to do the research they really need to do before buying a stock and many can be enticed to jump in on a "doubles in two months" sales pitch. MF should be more careful about making such claims.

    Certainly it is true that "highly innovative companies win out in the long run, and that heavy shorting could provide a turbo-boost to their stock price." That's not news and your acknowlediging it doesn't substantiate the original article. Certainly, it is true (and very obvious) that the ""long run" is measured in years and decades, not two months." Again, acknowledging this doesn't give you a free pass for what you originally stated. And certainly "stocks that are heavily shorted are just as likely to take a dive on the sign of bad news as they are to spike on word of good news." This is a huge risk that should have been discussed in detail in your original article.

    Suggesting that you could pick that unique two month period in which these stocks may (not, will) move is just like saying you can win at blackjack a majority of the time against the house. Only a novice says such things.

    It was good that you wrote the follow up article (although you still gave yourself somewhat of a pass) but you nor MF should be spouting this kind of speculation. We don't need to see boilerplate risk factors either but we need to see balanced, thoughtful writing, identifiy at least the key (and in your case, obvious) risks.

    Do better. We investors need good advice and to leverage off good research. Your theory was good, just not explored deeply enough.

  • Report this Comment On September 06, 2011, at 11:07 AM, oldengineer wrote:

    I strongly agree with TCNFool. I will continue to ignore any Brian Stoffel opinions. Fortunately I did not bite on the double in two months nonsense and doubt that many Fools did.

    OE

  • Report this Comment On September 06, 2011, at 1:17 PM, TMFCheesehead wrote:

    @TCNFool-

    Thank you for the thoughtful response. I think that in the end, the basic premise was right (innovation always wins out), but the title (and, therefore, the timeline) were misleading. Had it read, "These Stocks Could Double in the Next Two YEARS", it would have been far more appropriate (and realistic).

    Brian Stoffel

  • Report this Comment On September 07, 2011, at 8:49 AM, upndn wrote:

    Give him a break boys.

    I say well done Brian, we are all responsible for our own picks. His articles can be a starting place -not- the finish line for those picks. Anyone worth their picking salt knew TZOO SODA and others

    were richly priced and could have no hiccups at this point and time.

    **Buyer Beware** applies to every stock every day.

    UP

  • Report this Comment On September 07, 2011, at 9:42 AM, stoneteeth wrote:

    Brian, You are no better stock picker than Joe shmo on the street

  • Report this Comment On September 07, 2011, at 2:14 PM, modestfool13 wrote:

    ENTR is one of my heavily weighted stocks in my Roth... Ouch for now, but I haven't sold it for a reason... they should recover nicely

  • Report this Comment On September 09, 2011, at 8:47 AM, dbtheonly wrote:

    Brian,

    I agree that you are as prone to hits and misses as the rest of us. But isn't that the point? You put your opinion out there & it is up to us, your loyal readers, to decide what to do with it. We are after all readers, not followers.

    I do not understand the comments that suggest that with the "TMF" in your username; you were blessed with omniscience & infallibility. Perhaps they are just looking for the guru to reveal the truth to them. Regrettably those guru are not infallible either & often charge $ thousands per year for their sage advice.

    I appreciate your willingness to admit your errors & I assure you that I remain a loyal reader.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1548271, ~/Articles/ArticleHandler.aspx, 12/21/2014 5:01:33 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement