Time to Consider Unexpected Downside Earnings Risk

Just when everybody was gung-ho on the retail sector, particularly in electronics, Best Buy BBY apparently did not share their enthusiasm, and posted lower than expected results and lowered its outlook, causing the stock to drop almost 15% on Tuesday. According to the company, the miss was mostly due to a decline in sales of TV, notebook computers, and games. Armed with hindsights, many analysts/investors now proclaim that they knew this all along, and gave theories ranging from Best Buy high-end TV push did not work out, that they did not discount enough on Black Friday, to Amazon.com eating its lunch. No one seems to want to stick their neck out for Best Buy anymore. Whatever the reasons are for Best Buy's less than stellar results and its lowered outlook, it's the reaction of the stock market that's more interesting. It is obvious that people are now in a shoot-first, ask-second mood, either to protect their profit before year-end, or just turned negative on the stock after the result. With bullish sentiment far outweighing bear sentiment these days, we believe the sell off is clearly a signal for investors to be extra careful for companies with upcoming earnings reports. Since it's not earnings season yet, only a handful of companies are scheduled for earnings reports before the end of the year. While these companies' business may be booming, it is at least prudent to think of what can go wrong with them (not that they will). Some of the better known names reporting soon are:

• Federal Express FDX
  • Will rising fuel cost rile the party for Fedex?
• General Mills GIS
  • Will rising commodity price concern General Mills?
• Adobe Systems ADBE
  • Will its result go below its lowered outlook guidance last quarter?
• Red Hat RHT
  • Will Amazon dent the optimism for Red Hat, at least on its AWS platform?
  • Is Red Hat priced for perfection for an >50 forward P/E ratio?
• Nike NKE
  • Can anything go wrong for a well managed, well branded company who taught us to 'Just do it'? Are we crazy even to think about that?! But then, unexpected news always come from an unexpected corner.

Investors may not want to short the market, because the momentum is still strong, and instead of raising interest rates in 15 minutes, the Fed can also announce that it's not satisfied with the QE2 program, and pledge to buy $10 trillion US treasuries more. Nonetheless, Best Buy has just taught us a lesson that it's better to at least prepare for negative news. Daniel Ho is the founder of 10xreturn.com, a financial portal providing financial information and market statistics for investment professionals.