2008-09-18 23:54:02 -
- Zacks.com releases the latest Zacks Industry Rank. Stocks featured in this week's analysis includes American Financial Group (NYSE: AFG), American International Group (NYSE: AIG), Lehman Brothers (NYSE: LEH), Northern Trust (Nasdaq: NTRS) and Washington Mutual (NYSE: WM).
To see the Zacks Industry Rank and the trend in earnings estimates revisions for more than 200 industry groups, visit at.zacks.com/?id=3154.
Zacks Industry Rank Analysis is written by Charles Rotblut, CFA, Senior Market Analyst for Zacks.com.
This week: The Warning Signs for Financials
The importance of following earnings estimate revisions became very apparent this week. A simple practice of avoiding stocks with consistent negative revisions would have kept investors out of American International Group (NYSE: AIG), Lehman Brothers (NYSE: LEH) and Washington Mutual (NYSE: WM) - as well as many other beleaguered financial firms.
For many months, I've pointed out the negative trend in earnings estimate revisions for the financial sector. However, I realize it's one thing to tell you that our system worked and another for you to see the same results. Therefore, this week, I'm going to discuss the warning signals, as they occurred, for each of the aforementioned stocks. And I'm going to use data that is available - for free - on Zacks.com.
AIG Forewarned Investors of Problems
Last February, in this column, I discussed how AIG warned about growing subprime-related losses. The firm revealed in a SEC filing that its internal model underestimated losses for two of its subsidiaries. The firm said new calculations suggested a potential loss of $5 billion, instead of $1.6 billion.
Brokerage analysts had previously started cutting their 2008 earnings estimates prior to the announcement, so investors should have been cautious about the stock. The announcement gave an additional reason to stay out of the stock. What followed was a rapid decline in expectations for AIG and a corresponding plunge in the stock's price.
Between Feb 19 and Sep 16, the 2008 consensus estimate dropped from an expected profit of $6.62 per share to a projected loss of 81 cents per share. During this period, the stock price plunged from $47.03 to $3.75.
Late Tuesday night, the Fed threw AIG a lifeline. The Federal Reserve is loaning the soon-to-be former Dow component $85 billion at interest rates that are equivalent to what many credit cards charge.
Reversal of Trend for Lehman
Until last fall, there had been a history of positive estimate revisions for Lehman Brothers. This trend had lasted for several years, before completely reversing.
To explain this trend, I'm going to use you the Price & Consensus chart for LEH, which is available on the Zacks.com. This chart shows the trend in estimate revisions and movement in a stock's price.
What I like to see is an upward trend in estimate revisions and a corresponding move in the stock's price. This is what occurred with LEH between late 2003 and early 2008.
Starting in the summer, estimates for 2007 and 2008 started to weaken.
Then, throughout this year, forecasts for 2008 were continuously and sharply revised downward. As the outlook for Lehman worsened, its stock entered into a freefall. At any point last fall or winter, an investor looking at this chart would have had a big warning signal to get out of LEH.
A Lackluster History for Washington Mutual
What's interesting about Washington Mutual is that even when times were good, the stock never really rewarded shareholders. Between late 2003 and early 2007, there was not a meaningful difference in return between WM and a S&P 500 index fund.
The reason is that the company missed earnings expectations on several occasions, as the Price EPS Surprise chart shows.
The nearly routine negative surprises kept brokerage analysts from having much confidence in their earnings forecasts. As a result, even when the housing market in California was booming, the positive business momentum was not resulting in upwardly revised profit projections.
Conversely, when industry conditions turned against WaMu, brokerage analysts began cutting their forecasts en masse. After all, if a company failed to live up to expectations when times were good, it certainly isn't going to meet expectations when times are bad.
Lesson for Investors
Not all companies with negative estimate revisions will become the subject of bankruptcy rumors. However, many will disappoint and cost investors money. Given that all of the above information is available for free on Zacks.com, there is no reason for investors to ignore warning signs.
Though investing is often defined in terms of how one much makes, limiting losses also materially improves portfolio performance.
Positive Plays within the Financial Sector
Regular readers of this column know that I've been bearish on the financial sector since last year. The reason is that earnings estimates for the entire sector continue to be cut for both 2008 and 2009. Still, brokerage analysts are raising estimates on some financial companies.
One such company is American Financial Group (NYSE: AFG). Earnings estimates on this property and casualty (P&C) insurer continue to be revised higher for both 2008 and 2009. AFG has topped expectations nearly every quarter over the past five years, disappointing investors just twice. Best of all, the stock trades at about 7.5x 2009 earnings.
Northern Trust (Nasdaq: NTRS) may not seem like much of a bargain with its stock trading near a 52-week high. However, the company has a history of meeting or beating earnings estimates. Furthermore, profit projections for this year and next are being revised higher. NTRS provides asset management and investment advice to institutional investors and high net worth individuals.
Though both are Zacks #2 Rank ("buy") stocks, I want to stress that investors should conduct further research before investing in either company. AFG missed expectations last quarter and could be exposed to claims from hurricane Ike. NTRS trades at 17x earnings and could be adversely affected if the financial crisis were to worsen.
The interactive Zacks Industry Rank List allows you to see all of the companies, and their Zacks Rank, within more than 200 industries. See the list at
at.zacks.com/?id=3208.
About Zacks Industry Rank and the Zacks Rank
Zacks Industry Rank is calculated by averaging the Zacks Rank for all covered companies within a given industry. The Zacks Rank is assigned to approximately 4400 stocks and ranges from #1 ("Strong Buy") to #5 ("Strong Sell"). Both the Zacks Industry Rank and the Zacks Rank are quantitative indicators designed to cover periods of 1-3 months.
Since 1988, the Zacks Rank has proven that "Earnings estimate revisions are the most powerful force impacting stock prices." Since inception in 1988, #1 Rank stocks have generated an average annual return of +30%. During the 2000-2002 bear market, Zacks #1 Rank stocks gained +43.8%, while the S&P 500 tumbled -37.6%. Also note that the Zacks Rank system has just as many Strong Sell recommendations (Rank #5) as Strong Buy recommendations (Rank #1). Since 1988, Zacks Rank #5 stocks have underperformed the S&P 500 by 81% annually (+2% versus +11%). Thus, the Zacks Rank system allows investors to truly manage portfolio trading effectively.
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Zacks.com
Charles Rotblut, CFA
312-265-9352
pr@zacks.com
www.Zacks.com
