Avoid these 3 Roller Coaster Stocks During Earnings Season

“Whoooaaa!”

That was my 7-year-old’s reaction as we reached the outskirts of Cincinnati to visit family over Easter.

Just as we turned the corner, roller coasters from Kings Island reached into the sky in an amalgamation of steel.

Now it’s been a while since I’ve been on one of the rides, but I enjoy the thrill as much as my kids.

However, there’s one place where I haven’t enjoyed the roller coaster ride, and that’s been in the stock market.

The ups and downs, twists and turns … and I’m afraid the ride isn’t over yet.

In fact, here are two factors that could send the stock market coaster lurching even more in the coming weeks … and three popular stocks you won’t want to take on the ride.

Factor No. 1: Profit Revisions Are Headed Down

We’re just now entering prime-time earnings season, with companies like Tesla and Apple reporting quarterly results over the next several weeks. And it’s the outlook that will be critical.

That’s because investors will discover how much supply chain issues, inflation and tight labor markets are impacting the bottom line looking ahead.

It’s still early, but analysts at Morgan Stanley point out that earnings revisions are collectively approaching negative territory for companies that have already reported.

That means there are more companies lowering estimates for future earnings versus increasing projections, and it could just be the start.

 

Factor No. 2: Credit Risk Rises With Rates

Members of the Federal Reserve keep trying to “talk” their way into a tightening cycle, and it’s working.

The yield on the 10-year Treasury is at 2.9% as I’m writing this. That’s up from 2% in just a little over a month. Meanwhile, the 30-year Treasury hit 3% … the highest level in three years!

Yet Fed members keep hinting that it could just be the beginning … making high stakes even higher ahead of the Fed’s next meeting in just two weeks.

That’s important because yields in the $10 trillion corporate debt sector are surging higher as well. You can see that in the chart of BBB-rated bond yields below.

For companies that need to refinance all that debt, it translates to increased borrowing costs. Those higher expenses slowly eat into profits, which can drive the revisions I mentioned earlier even further into the red.

And for heavily indebted companies, a large enough jump in interest expense can lead to default and essentially wipe out stockholders.

 

Avoid These 3 Roller Coaster Stocks

Not all roller coasters are bad. My kids definitely appreciate that fact!

But given these somewhat unpredictable factors, it makes sense to avoid companies that could send investors for a “ride” after seeing downward revisions to their profit forecasts and running high-risk balance sheets. Using quantitative analysis, it’s easy to screen for companies that could be vulnerable to those catalysts. These same factors have been proven in back testing to pinpoint companies that outperform or trail the market.

As we enter this pivotal earnings season, I looked at which companies in the S&P 500 rank poorly when you combine negative analyst revisions and high credit risk, and here are three that stand out among the lowest scores:

It’s sort of surprising that all three are household names — but they’ve also all been deeply impacted by the global pandemic. But the numbers don’t lie.

So if you’re not looking for a pulse-pounding thrill ride over the next few months, you might want to steer clear of these popular consumer brands.

 

Best regards,


Clint Lee
Research Analyst, The Bauman Letter

 

 

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