It’s a simple question, but one with a handful of difficult answers: Will earnings season lift stocks to new all-time record highs?
Certainly, while the bearish case is an obvious choice, it’s been a losing investment strategy so far in 2013 as the Dow Jones Industrial Average and S&P 500 indices continue to make new all-time highs. The Nasdaq technology index finally caught a headwind in April after International Data Corporation released an ugly forecast for the PC market. Recent data from IDC indicates that PC shipments fell 13.9% among the top 5 computer vendors during the first quarter, causing shares of Hewlett-Packard Company (NYSE:HPQ), Intel Corporation (NASDAQ:INTC), and Microsoft Corporation (NASDAQ:MSFT) to fall heavily on the news.
I remain focused on identifying investment opportunities based on company-specific analysis, and use the market indices only as a barometer for overall market health. Here are three stocks in my mind with high conviction to either buy or sell ahead of first quarter earnings.
Caterpillar Inc. (NYSE:CAT)
Monday, April 22, 2013 before market open; EPS $1.44 / Revenue $13.81B
Caterpillar Inc. (NYSE:CAT) is the world’s largest manufacturer of industrial machinery, and therefore its business prospects are tied heavily to the strength of the global economy. The company’s North American business (external website) is quickly rebounding as commercial construction and residential housing resume upward trends.
However, two concerns are threatening Caterpillar Inc. (NYSE:CAT)’s fundamentals: 1) weakness in the global mining industry with resulting job layoffs and 2) the weakening Yen currency which helps Japanese export manufacturers.
In early April, Caterpillar Inc. (NYSE:CAT) announced that it was laying off 460 mine workers in Decatur, Illinois in order to bring supply in line with market demand. Industry experts agree that the layoffs were spurred by weakening demand for coal as U.S. power plants begin to utilize clean and abundant natural gas. The demand shift has resulted in fewer equipment sales for Caterpillar Inc. (NYSE:CAT) and competitor Joy Global Inc. (NYSE:JOY).
The second reason I recommend that readers sell Caterpillar Inc. (NYSE:CAT) is due to the Japanese Yen. Komatsu Ltd is the #2 global manufacturer of industrial machinery behind Caterpillar Inc. (NYSE:CAT), and the weakening Yen will cause Komatsu’s excavators and backhoe loaders to be priced more competitively than Cat’s American made counterparts. The same holds true for Toyota Motor Corporation (ADR) (NYSE:TM) and Honda Motor Co Ltd (ADR) (NYSE:HMC) vehicles when compared with our domestic Ford Motor Company (NYSE:F) and General Motors Company (NYSE:GM) (although some manufacturing is completed here and in Mexico).
In its semi-annual currency report to Congress, the U.S. Treasury issued a warning to both China and Japan regarding competitive devaluation of their currencies, but stopped short of labeling the Asian economic powers as currency manipulators.
The business weakness at Caterpillar has led a handful of Wall Street firms to lower their price targets on the stock. Analysts at Bank of America, Credit Suisse, and Wells Fargo all cut their targets more than 10% to $95, $90-$93, and $110 within the last week.
While the Wall Street target price is still higher than recent market prices, I recommend that readers sell Caterpillar ahead of Monday’s earnings report.
Texas Instruments Incorporated (NASDAQ:TXN)
Monday, April 22, 2013 after market close; EPS $0.30 / Revenue $2.85B
On March 7, Texas Instruments Incorporated (NASDAQ:TXN) hosted a mid-quarter conference call to provide investors with an updated business outlook. Management narrowed its Q1 earnings and revenue guidance to the higher end of a previously announced range. Earnings per share are expected at $0.28–$0.32, while revenue is anticipated at $2.8 billion–$2.91 billion for the quarter ending March 31.
While the raised guidance is certainly a positive in isolation, Wall Street analysts aren’t convinced that the forecast is indicative of improved business prospects going forward. Texas Instruments Incorporated (NASDAQ:TXN) announced during fall 2012 that it would be exiting the wireless business, choosing to focus on a segment called embedded processing. Wall Street believes that the Q1 strength can be attributed to wireless, and Texas Instruments Incorporated (NASDAQ:TXN) will be soon departing this segment.
Texas Instruments Incorporated (NASDAQ:TXN) currently manufactures the CPU for Amazon.com, Inc. (NASDAQ:AMZN)’s Kindle Fire HD, as well as Barnes & Noble, Inc. (NYSE:BKS)’s Nook HD+. However, the strength in wireless will be short-lived, as competitors QUALCOMM, Inc. (NASDAQ:QCOM) and Broadcom Corporation (NASDAQ:BRCM) continue to manufacture processors for the newest smartphone and tablets.
Ahead of Monday’s earnings call, analysts at Sanford Bernstein, Stifel Nicolaus, and Susquehanna all downgraded Texas Instruments Incorporated (NASDAQ:TXN) to “hold” from “buy” based on valuation and anticipated slowdown in business. Susquehanna has the lowest price target for Texas Instruments Incorporated (NASDAQ:TXN) at $30.
Wall Street continues to view competitors QUALCOMM, Inc. (NASDAQ:QCOM) and Broadcom Corporation (NASDAQ:BRCM) more favorably than Texas Instruments within the semiconductor space. For an in-depth report on Qualcomm, reference my article Forget Apple and Google, Buy this Fast-Growing Tech Stock.
I recommend that readers sell Texas Instruments ahead of Q1 results, as reduced guidance for full-year 2013 will cause the stock to trade lower.
Yum! Brands, Inc. (NYSE:YUM)
Tuesday, April 23, 2013 after market close; EPS $0.58 / Revenue $3.09B
Yum! Brands, Inc. (NYSE:YUM) is an international quick service restaurant operator with more than 37,000 restaurants in 120 countries. Investors have traditionally considered Yum! a growth stock with its emerging markets exposure in large countries such as China.
Market participants have repeatedly failed to gather upward momentum in Yum! Brands, Inc. (NYSE:YUM)’s share price, as new concerns in China have caused the stock to attract more sellers than buyers. I originally wrote back on March 12 that I was looking for more visibility before considering an investment.
On April 10, Yum announced that March same-store sales declined a massive 13% over concerns related to the Avian flu. The Chinese public are concerned that the deadly virus may have entered the chicken food supply, therefore refraining from eating at Yum’s KFC restaurant locations.
Wall Street has mixed views on the outlook for Yum! Brands, and my investment experience indicates that it’s better to stay safe on the sidelines versus becoming a hero by putting both feet in the water. Analysts tend to be overly optimistic (i.e. bias towards management) and exuberant during times of business stress, which could lead to unwanted losses on your hard-earned capital.
Aside from China, the Associated Press is reporting that Yum! is planning to revamp its Taco Bell menu in order to stay competitive and introduce healthier menu items, a trend set by competitors McDonald’s Corporation (NYSE:MCD) and newcomer Burger King Worldwide Inc (NYSE:BKW).
I recommend that readers sell Yum! Brands ahead of Tuesday’s earnings release.
Foolish Bottom Line
While the broader market may go higher, lower, or sideways from here, Fool readers do not have to be market forecasters in order to manage their individual stock positions.
In my opinion, a deterioration in business fundamentals warrants the sale of Caterpillar, Texas Instruments, and Yum! Brands ahead of first quarter earnings.
Thanks for reading, and consider subscribing to my posts for more Foolish ideas on outperforming the market.
The article 3 Stocks That Must Be Sold This Week originally appeared on Fool.com and is written by John Macris.
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