Today is one of those days when you're just cruising along, minding your own business, and a market truth comes streaking out of your blind spot and takes out your right fender, or maybe even totals your buggy. This morning, I awoke, as did many (probably unhappy) shareholders, to find that one of my holdings, New York & Co. (NYSE:NWY), was once again lowering guidance, on the heels of lukewarm sales. (It dropped 5% early this morning, and I can't say I disagree with that discount.)
That alone does not constitute a tragedy. But here's what might qualify. I've been expecting a disappointing earnings release for a while. I've written in the past about how this Motley FoolHidden Gems pick isn't really getting the job done, and last month's atrocious same-store sales convinced me that a storm would be a'brewin. The trouble is, I have kept hoping that New York & Co. will get its act together.
Hope is for hosers
How's that for a lame investment thesis? "I hope they'll do better?"
Yet that has been the core reason I've held New York & Co. In theory, I like the turnaround story, and I am one of those people who like a retail resurgence, having made a good bundle of money on retailers in the past. Unfortunately for me, New York & Co. isn't Guess? (NYSE:GES), which worked improving efficiency into major earnings growth (and share price appreciation) by simultaneously ramping up sales. Chain retailers live by the sword and they die by the sword, the sword being leverage. When sales ramp up over fixed, or relatively stable costs, earnings fly -- as they did with Guess? When they stagnate or go negative, earnings can whipsaw the other way, especially given the margin-chewing discounting that usually accompanies lagging sales.
That, of course, is how a smallish, 5% sales slip can turn into a 50% trim for earnings expectations. (Ouch.)
Hope springs eternal
Unfortunately, we all fall victim to this, sometimes the worst of investing theses. We hope the current, (peaking?) cyclical earnings strength will continue -- see oil drillers. We hope that, though a stock is insanely overvalued, that won't matter because we'll find a crazier buyer to dump it on later -- see Travelzoo last year. We hope that Apple (NASDAQ:AAPL) will come out with a living-room media computer to justify its hefty price tag. We hope that Google will continue to grow like a 40%-per-year-forever weed even though it's already sort of admitted that it can't, by paying that ransom to Time Warner and raising cash for future acquisitions.
Or, we hope that we can catch the coattails of the next big thing, such as with the little soft-drink maker National Beverage (AMEX:FIZ). Here, in this sleepy maker of Shasta, we find an unhealthy dose of "Hey, we got the next Hansen Natural (NASDAQ:HANS)!"
National Beverage seems a fine little business: lukewarm sales, not much leverage to the upside on margins, some healthy free cash flow. But to justify the current price, you have to hope it will generate earnings growth in excess of its past efforts, and many (like Jim Cramer) hope that it's going to do it based on its "Rip It" energy drinks, which compete with approximately one bazillion others. Sure, that growth could happen. But if things continue as usual? Then you're looking at a stock that is, by my estimation, worth 25% to 30% less than the going price.
Give up hope?
At first, it might be tempting to create a little rule, as I did this morning. You can express it mathematically as:
I hope = I don't know
I don't know = I don't buy = Sell
I think there's a great deal of sense in that. After all, investing is about figuring the odds and paying accordingly. How do you calculate the future value of "I hope they turn around and sell stuff like crazy?" Well, you can't. That's why I firmly believe that when you are trying to value a company based on the present value of predicted cash flows, "I don't know" should equal "I don't buy."
But that doesn't mean giving up hope entirely. For instance, it's pretty tough to predict the commodity winds and the share price fallout for the likes of Sanderson Farms (NASDAQ:SAFM) or Pilgrim's Pride (NYSE:PPC). But if you can snap up such companies when they're selling near book value, well then you've got a backstop that makes "I don't know" a lot less relevant.
Similarly, if you're looking at a retailer and your growth model is a shoulder shrug, you'd best get your shares when the Street expects no growth or worse, and has priced it accordingly. If you've got nothing more to bank on than hopes and dreams, make sure you pay as little as possible, so you won't be out too much cash if it turns into a nightmare.
Seth Jayson still hopes New York & Co. will pull it together. (Some people never learn.) At the time of publication, he had shares of New York & Co. and Guess?, but no positions in any other company mentioned. View his stock holdings and Fool profile here . Time Warner is a Stock Advisor recommendation. Fool rules arehere.
