Despite setting two consecutive record highs at the beginning of the week, U.S. stocks were flat on the week, with the benchmark S&P 500 down less than 0.1%. The narrower Dow Jones Industrial Average (DJINDICES:^DJI) fell 0.6%, while the technology-heavy Nasdaq Composite Index (NASDAQINDEX:^IXIC) rose 0.5%. Among the biggest movers of the week: Cisco Systems (NASDAQ:CSCO) (+5.9%) and J.C. Penney (NYSE:JCP), (10.6%) both of which rallied on better-than-expected quarterly earnings reports.
When it comes to earnings reports, the financial media and, consequently, investors place too much weight on whether a company beats or misses analysts' consensus estimate. Bear in mind that the company has already banked those earnings, whereas the stock price reflects the stream of expected future cash earnings. Historical earnings are only important inasmuch as they contain information about a company's outlook. Cisco Systems is a good illustration of this principle.
On Wednesday afternoon, the networking equipment company announced adjusted earnings per share for its fiscal third quarter ended April 26 of $0.51, $0.03 ahead of the consensus estimate; the following day, shares shot up 6%. However, Cisco had beaten the consensus estimate, by $0.01 and $0.02, in the previous two quarters and the shares then fell 3% and 11%, respectively. The difference this week all came down to an updated outlook that was evidently more positive than the one investors were factoring into their valuations, with Cisco CEO John Chambers (guardedly) asserting that Cisco will return to mid-single-digit revenue growth in the future. (We're not there yet, clearly -- total revenues declined 5.5% year-on-year in the last quarter.)
Two quarters ago, Cisco's guidance gravely disappointed analysts (even though it now looks spot-on), so Wednesday's announcement helps to correct the negative sentiment that has been weighing on Cisco. It also suggests that the changes in investor expectations are more volatile than what is warranted by the company's outlook and actual results. Bottom line: At a forward price-to-earnings multiple of 11.3, per Morningstar, Cisco shares appear to offer adequate long-term value.
Whether the same can be said for the shares of struggling retailer J.C. Penney is much less clear, but they also benefited hugely this week from results that exceeded Wall Street's expectations. The shares surged 16% on Friday after the company published results on Thursday afternoon that slightly exceeded analysts' (abysmal) consensus estimate of a $1.25 loss – the actual loss was only $1.14. More significantly, perhaps, the company has rolled over its credit facility into a larger $2.35 billion loan, quelling investor concerns about a possible liquidity crisis.
Here again, it now appears -- with the benefit of hindsight, admittedly -- that investor pessimism regarding the company had become extreme and, therefore, small improvements were all that were required to lift the shares off their bottom. J.C. Penney's stock has roughly doubled off the $4.90 52-week low it put in on Feb. 4 and Feb. 5. Nevertheless, I think it's quite possible that Friday's action now represents excessive investor optimism and that the positive correction in the shares has gotten ahead of a realistic assessment of J.C. Penney's prospects (which still don't look very healthy). I think it's unlikely that Friday's closing price of $9.73 (or even Thursday's pre-prop price, for that matter) will prove to have been a good value if we look back at this situation over an investor's timeframe, three to five years from now, say.
Next week's big mover: Look for shares of DirecTV (NASDAQ:DTV) to rise next week, if, as was reported in The Wall Street Journal on Saturday, the company is about to announce a takeover offer from AT&T in the mid-$90s per share.
Alex Dumortier, CFA, has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Cisco Systems, and DirecTV and owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.
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