As I mentioned earlier this week, earnings season reminds us that it’s important to make sure you own stocks that will show strong fundamentals and attract institutional buying power to move prices higher. But it’s just as important to avoid stocks that may have disappointing earnings and attract widespread selling. As in football, you won’t win many games with just offense. Your defense has to protect your lead and keep gains intact.
Avoiding stocks with poor fundamentals and a history of negative earnings momentum and surprises can keep you from taking losses that offset the gains from your superior stocks.
On stock in the S&P 500 that appears to have deteriorating fundamentals and should be avoided by most investors is Chipotle Mexican Grill (NYSE:CMG). The stock has an overall grade of “C” in Portfolio Grader but earnings momentum has been slipping and the company has posted two consecutive earnings disappointments. The consensus EPS estimate for the quarter was $2.22 at the start of 2013 and is now down to just $2.14. Same-store sales growth is slowing and the company will be dependent upon new store openings to capture revenue growth. The stock is a favorite of many investors, but they have likely stayed at the party too long — Portfolio Grader began downgrading the stock last year.
UPS (NYSE:UPS) has developed a history of poor earnings result and could cause losses for investors if they miss earnings again. The company has disappointed on earnings in three of the past four quarters, and analysts have been steadily lowering their estimates for this quarter and full-year 2013. International and supply-chain revenues are expected to be weak again this year; the company is totally depended on the domestic U.S. market. Unfortunately there are signs of consumer weakness, which could once again hurt the bottom line for UPS.
Finally, Wynn Resorts (NASDAQ:WYNN) is a stock that is loved by Wall Street but has shown signs of dangerously deteriorating fundamentals. The company has posted a negative earnings surprise in three of the past four quarters and is susceptible to a selloff should they fall short once again this quarter. Revenues fell in 2012 as Macau gambling growth tapered off and Las Vegas continued to be weaker than expected. The consensus estimate has been steadily declining — this type of downward revision often leads to a negative surprise and a sharp correction in the stock price.
Success in investing is not just about picking the winners with the best fundamentals. You also have to avoid those issues with declining fundamentals that may experience heavy selling and large losses. There’s plenty to think about as we head into earnings season — make sure you do your homework.