Apple Inc.: A Case Study On the Importance of Expectations

As most of you have probably heard by now, tech mogul Apple Inc. (AAPL) reported third-quarter earnings that fell short of analysts’ estimates, sending the shares lower as a result. But, as SmartMoney columnist Jack Hough notes, “Normally, a 54% profit jump would be impressive even for a promising start-up in a booming economy.” Furthermore, the author points out that although AAPL’s iPhone sales missed Wall Street’s mark, they rose a year-over-year 21% — pointing to healthy demand, and underscoring the Schaeffer’s philosophy that sentiment should never be overlooked.

And, now more than ever, AAPL investors are also learning why too-high expectations can come back to haunt a stock, despite arguably solid fundamentals and a longer-term uptrend. In fact, speaking like a true contrarian, Hough warns prospective AAPL buyers not to rush in anytime soon. “Analysts are sure to revisit their remaining forecasts in coming weeks and a few might even issue downgrades,” he cautions, which could send the security even lower.

Contrarian Takeaway:

If there ever were a poster child for a Wall Street darling, AAPL just might be it. According to Zacks, a whopping 35 analysts consider the stock a “strong buy,” with another three doling out “buy” ratings. For comparison, just three brokerage firms rate the equity a “hold,” and not one considers it a “sell” or worse. Should the analyst crowd downwardly revise their opinions in the wake of AAPL’s earnings miss, a bullish exodus could exacerbate the stock’s slide.

Elsewhere on the Street, options traders have also upped the bullish ante on AAPL. The stock sports a 10-day call/put volume ratio of 2.23 on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), indicating that traders have bought to open more than two AAPL calls for every put during the past couple of weeks. What’s more, this ratio registers in the 95th annual percentile, implying that speculators have rarely initiated bullish bets over bearish at a faster clip during the past year.

Echoing that trend, the security’s Schaeffer’s put/call open interest ratio (SOIR) rests at 0.74, indicating that calls comfortably outnumber puts among options slated to expire within three months. Plus, this ratio stands just nine percentage points shy of a 52-week low, suggesting near-term options players are much more call-heavy than usual on AAPL. An unwinding of optimism in the options pits could also amplify the selling pressure on the equity.

Andrea Kramer (akramer@sir-inc.com)

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Contrarians Should Proceed with Caution on Netflix

Netflix (NFLX) took a notable nosedive earlier this week after a poorly received earnings report, and this gloomy article warns that the stock’s single-day slide of 35% could be just the beginning. The author cites daily volume data indicating that “there are lots of individual investors who bought high who still own shares” — which means that any future rallies in NFLX could quickly be met with selling pressure, as these investors attempt to minimize their paper losses. As evidence, the author describes similar scenarios that played out with former momentum leaders First Solar (FSLR) and Oracle (ORCL), which have yet to revisit the highs of their own respective glory days. In addition to the threat of pent-up selling pressure on the sidelines, the article also cites “plenty of legitimate fundamental questions” about NFLX’s business, particularly after the PR nightmare that was Qwikster.

Contrarian Takeaway:

Following its earnings-related plunge, NFLX is certainly staring up at some serious technical roadblocks — including its 40-month moving average, which contained the equity’s steep slide during the month of September.

Meanwhile, from a sentiment perspective, traders have shown a strong preference for bullishly oriented options on the beaten-down stock. During the past 10 days, speculators on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) have bought to open 1.36 calls for every put on NFLX. This ratio rests in the 100th annual percentile, implying that traders have been scooping up calls over puts at an annual-high pace in recent weeks.

One silver lining, from a contrarian standpoint, is NFLX’s healthy short-to-float ratio of 17.5%. However, at the equity’s average daily volume, it would take less than one day for all of these bearish bets to be covered. During the near term, as the author suggests, NFLX shares could continue to struggle on the charts.

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Oil Soars: These Energy Areas Are Next – Voice of the People

Oil Soars: These Energy Areas Are Next

As spot crude oil has pushed through the $100 level, the upside is somewhat limited. Oil is up over 30% in the last six weeks and with the global economy still weak, it is hard to imagine it will push much higher. Investors are searching frantically for the next big energy area. There are some obvious places that money should start to flow.

Natural gas continues to be the obvious answer to some easy money upside. With oil back above $100, a natural switch towards the cheap natural gas should begin. Natural gas is a cleaner and cheaper energy source. With the commodity trading at or near 52 week lows, it makes sense in this range. Some natural gas stocks to watch are Chesapeake Energy Corporation (CHK – Analyst Report) and Devon Energy Corporation (DVN – Analyst Report).

Another possible area for investment is in solar stocks. This sector has been crushed but as it trades at multi year lows and oil moves over $100, it begins to make sense as a speculative investment. Best of breed stocks like First Solar, Inc. (FSLR – Analyst Report) and cheap China solar producers like Suntech Power Holdings Co., Ltd. (ADR) (STP – Analyst Report) are likely to appreciate over the next year from current levels.

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Can Coinstar Capitalize on Netflix’s PR Problems?

Rival Netflix (NFLX) has made a few high-profile PR blunders in recent weeks, but this article cautions that “investors still need to watch where they are going” with Redbox kiosk operator Coinstar (CSTR). Speculation on Wall Street suggests that CSTR could snag a healthy share of NFLX’s defecting DVD customers, but it’s worth noting that the DVD-rental industry isn’t necessarily a growth industry. Netflix’s own strategic shift reveals that the company thinks streaming content is the wave of the future, and that field is crowded with competition from cable providers, websites such as Hulu — and, of course, Netflix itself. Redbox has yet to create a streaming service of its own, suggesting the company is already behind the competitive curve. As a result, warns the author, “investors should pause before putting pennies into Coinstar.”

Contrarian Takeaway:

In addition to the concerns about Redbox’s relatively narrow business model, CSTR’s technical performance has been less than impressive. The stock is down 22.5% year-to-date, and CSTR has been pressured by unflagging resistance at its 10-week and 20-week moving averages since late July. Going forward, these trendlines could continue to create technical trouble for the shares.

Despite the weak price action, though, analysts remain generally upbeat toward CSTR. Zacks indicates that nine analysts maintain a “strong buy” recommendation on the struggling stock, along with six “holds” and zero “sells.” As CSTR continues to trend lower on the charts, the equity’s woes could be exacerbated by downgrades. As it stands now, it seems that any investor enthusiasm related to Netflix’s controversial changes may be premature.

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What is the most robust investment strategy? – Voice of the People

What is the most robust investment strategy?

That is the set of investment rules that has proven to be profitable with minimum risks (drawdowns) over prolonged periods of time.

Do those rules exist? Yes, they do.

Just back test the total collection of 14,022 active and inactive stocks in Research Wizard and see that these 14,022 stocks combined compounded 7436%/year with a maximum drawdown of -26% over the past 12 years. That scan takes a full 10 minutes on my new laptop and immediately reveals the errors in the Dbase.  But even without these errors, this is the most profitable and safest portfolio approach ever.

But it is not practical. The portfolios are equally weighted and the smallest stocks that only trade a few shares are pushed up by buys much more so than being pushed down by a sell. That asymmetry in those very small stocks is responsible for these tremendous gains, not any fundamental. When you take out these tiny stocks by imposing daily dollar volumes in excess of $500,000 and share prices larger than $1.5 and cap sizes larger than $100 million, you are left with 3446 stocks that suddenly only compound 6.4%/year with the high risk of a maximum drawdown of -60%. When you take the 200 smallest stocks of that collection, you start compounding 22%/year with a somewhat higher risk of -71%. There are only 200 ZR#1’s fulfilling those minimum size requirements. These 200 ZR#1’s compounded 18%/year over the past 12 years with a -54% risk. Hence, not using fundamentals gives you a +4%/year edge over the 200 ZR#1 stocks of the same liquidity.

If you would know the share price a week from today, you could make tremendous amounts of money. Just program in RW the selection rule i5[Recent+nW]/i5[Recent]>0, so that you only select stocks that increase in share value during the next  n weeks (n=1, 2, 3, ….). When you apply such forward testing on earnings or margins, you don’t compound steady gains. However, you do compound steady gains when you apply such foreknowledge to estimate revisions. For instance, try i44[Recent+3wks]>0. When parties are holding back that information, they could make enormous amounts of money.

Back testing is only a reliable tool as long as your watch list of back-tested stocks doesn’t change over time. Hence, when a stock of your list becomes inactive, your back-tested results change, as this stock is not available any more. Zacks retroactively started to put back the inactive stocks in its dbcmhist in November 2009. It showed that the back-tested results of mid and large caps were hardly affected by the inclusion of inactive stocks. This so-called survivor bias is more important for the smaller caps.

So are there relatively stable watch lists from which you consistently, over 20 to 32 years, can pick sub selections of up to 50% of those stocks and then steadily compound up to 40-50%/yr with maximum risks between -15% and -30% and hardly suffer from survivorship?

The answer is yes, you can, without using any fundamental or TA analysis. Our 32-year deep back-test programs and quantitative watch-list design just proves that to be true. Does that mean that 32 years of proven past performance holds any promise for future performance? Except for using foreknowledge or flash trading, it is the best you can do. But stocks are like neutrinos. Neutrinos don’t carry any charge and are thus invisible for light waves. Pure mass is only inertial without any wave character. That lack of wave character is also with stocks and prevents you to make any future prediction with any certainty. Heisenberg’s uncertainty principle doesn’t hold for particles without a wave character. It doesn’t hold for neutrinos and stocks. You can only manipulate them when you have the instruments.

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