No, it's not the economy. It's the company.
Often, when one company in a given industry reports a blowout quarter, other companies -- competing companies -- within the same industry get a boost from the news. For whatever reason, when you hear that Intel posted good sales, this lifts not just Intel's stock, but AMD's as well. Conversely, when Nucor reports rising levels of inventory and a slower rate of profits growth, that can hurt the stock of competitors like U.S. Steel or Mittal.
The theory -- termed "pin action" by certain CNBC sages who shall remain nameless -- seems to be that when a company does well, it's not just the company that's doing well, but the economics of the entire industry in which it operates. Competitors aren't so much expected to suffer from being beaten at their business by a worthy foe, as to benefit from whatever trend fortuitously lifted that foe's fortunes.
That seems to be the theory, at least. In practice, it doesn't always work that way.
Take, for example, the recent case of two of America's better known manufacturers of body armor and the ceramic plates that make them bulletproof: DHBIndustries (AMEX:DHB) and Ceradyne (NASDAQ:CRDN). Last week, early Thursday morning, Ceradyne reported a blowout quarter. Its second-quarter revenues leapt 129% over the numbers it posted one year ago. Its profits per diluted share climbed as well -- if not quite so steeply, then still steeply enough: up 77% from Q2 2004. Based on that news, Ceradyne's stock price jumped 13% in just a few hours of Nasdaq trading.
In sympathy with Ceradyne's good news, the stock of competitor DHB moved up as well, about 4% over the course of the day, as investors thought: "It's not just Ceradyne. The whole armor-making industry is doing well. So when DHB reports results after market close, it's going to go up, too."
Wrong-o. DHB actually plunged on its news later that day, for reasons you can read about right here.
So, in short, investing isn't bowling. One fallen pin does not a strike make.
Speaking of which, Foolish investors should take a close look at the pin named "Ceradyne," which got knocked into the stratosphere on Thursday. While the company's sales and profits soared impressively, the quarter did contain a couple of yellow flags that bear watching. Net margins declined from 16.6%, to 12.7%. And the $1.1 million in free cash flow that the company generated year to date was only a fraction of the $17.4 million in GAAP year-to-date profits it claimed.
That's not to say the company is a cracked pin or that its performance in the quarter wasn't excellent. Just that it might not have been as excellent as it was cracked up to be.
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Fool contributor Rich Smith does not own shares in any company named above.
