Reacting to News: The RIMM Lesson

How the market reacts to news can be very revealing.  Twenty years ago, when a stock halted trading I was often asked by our trading team where it would reopen.  The problem is understanding the framework of the analysts following the stock and the overall market environment.  The same news can have a widely differing impact based upon the market circumstances.  I have occasionally worked as an expert witness on matters relating to news.  The key is to look at comparable companies and determine the market background.

The modern era is different.  Every commentary reflects knowledge of where the stock is trading after hours.

The Research in Motion Example

Research in Motion (RIMM) announced earnings that beat the official Street expectations by 3 cents (3%).  The revenues were about $90 million light (2% or so).  Gross margins were solid at 44.1%.  New handset growth was 5% short of expectations.  The outlook was in line with expectations.

In a neutral market environment the stock might be down 3-4%, but the current market is not neutral.  In after-hours trading the stock is down 12%, and tomorrow's reports and commentary will reflect this market reaction.

The Investment Lesson

The macro view.  The market is "teed up" for a focus on revenue.  The bearish argument has been that corporations achieved good earnings last quarter through cost cutting.  Here at "A Dash" we understand and accept this behavior.  Companies cut back on costs and employment.  They will hire slowly and reluctantly.  They are lean and mean.  If the economy continues to improve, revenues will grow and earnings will grow faster.  Slow hiring, wise for an individual company, undermines the need for the economy to add employment.  It will be a mixed picture for many months.

In addition, many are looking for a reason to sell after a big rally.  Dow 10,000, while meaningless to professionals, has a psychological impact.  Technicians see S&P 1050, which will be challenged tomorrow, as a key support point.

Briefly put, the market will be unforgiving when companies miss on revenues.  It will be doubly so when the company does not provide a bullish outlook.  Few can be expected to do so in a time of economic uncertainty.  Many companies are not even providing guidance.

It is a clear choice for investors in this stock and others:

If you see a depression as "off the table" and a period of reasonable growth, revenues and great earnings will follow.

Those who hate government data and prefer specific company reports and anecdotal information (the Power Lunch economic index comes to mind) will find plenty to worry about.  We highlighted this in April in our article, Jim Abbott and the Wall of Worry.  Our viewpoint, now proven to be correct, was met with plenty of skepticism.  The worries continue.

It would be naive to expect the market to move in a straight line.  That is too easy.

The RIMM viewpoint.  We own RIMM in our own account and those of many clients.  We have been looking to add a good growth stock for more recent clients, and will add RIMM in the coming days.  Despite today's report, the prospects are very good.  Jordan Kahn at RealMoney (subscription required) sees earnings of $5 next year and a target of $100 in a year or so.  Every portfolio should have a growth component, and this is a great candidate.

Since we are aware of possible market share loss to Apple (APPL), our clients also own that stock.  We expect both companies to benefit from the growing mobile Internet market.

Final Take

We expect to see this story repeated many times during the earnings season.  There have been few negative pre-announcements, but companies use earnings as the trigger for those statements.  There will be revenue misses.