An undecided market has apparently moved back to a “risk off” mentality. The S&P 500 now sits roughly 7% off all-time highs reached in late January, after falling nearly 3% so far this week. Whether it’s a potential trade war, concerns about social media stocks driven by revelations about Facebook, Inc. (NASDAQ:FB) or higher Treasury yields, investors seem a little spooked at the moment.
That sets up an interesting few weeks for the U.S. equity market. Earnings season will begin again in less than a month. Tax reform will benefit those results. Macro trends remain strong. There should be more good news on the horizon. The key question in the near-term is how investors will react to that news.
Three earnings reports next week should provide clues. All three of these companies have been market darlings of late, with huge gains over the past year. But those gains have led to potentially stretched valuations. With a ‘cloud’ leader, a consumer stalwart, and a tech turnaround all in the group, there’s a nice cross-section of sectors that could be hit if the “risk-off” sentiment strengthens.
As such, these three reports should give investors an idea of how the market might react to strong quarters from expensive companies when earnings season begins in earnest.
Earnings Reports to Watch: Red Hat (RHT)
Earnings Report Date: Monday, March 26, after market close
Fiscal Q4 earnings from Red Hat Inc (NYSE:RHT) will be an interesting gauge of the market’s willingness to pay up for fast-growing tech stocks. There’s little doubt about Red Hat’s growth prospects. The Street is looking for 21% revenue growth and a 33% increase in earnings-per-share in the quarter. Red Hat’s numbers could be even better, as the company has a long-running track record of beating consensus estimates.
And Red Hat has a compelling story. Continuing Linux adoption and the company’s exposure to ‘cloud’ trends both have driven much of the optimism behind the stock over the past few years.
But the question coming out of earnings will be: at what point does price matter? RHT stock already has gained 28% in 2018 alone. It has risen 90% in the past year. Red Hat now is trading at a whopping 45 times fiscal 2019 EPS estimates, and almost 10x trailing twelve-month revenue.
There’s no doubt that Red Hat is a wonderful company. I’ve recommended it to my GameChangers subscribers several times over the past few years. But at this valuation, in a clearly more nervous market, the stock looks simply too vulnerable to a post-earnings sell-off. Red Hat’s Q4 numbers, and FY19 guidance, likely are going to have to be perfect to keep the rally going.
Earnings Reports to Watch: BlackBerry (BB)
Earnings Report Date: Wednesday, March 28, before market open
BlackBerry Ltd (NYSE:BB) has made some progress in its turnaround. BB stock has gained 82% over the past year, and hit a four-year high in January before pulling back.
There’s reason for optimism. BlackBerry is heading into its second act, so to speak. The smartphone business is outsourced to partners who pay BlackBerry a licensing fee. The company’s QNX software looks like it could become a part of the autonomous driving environment. A recent partnership with Microsoft Corporation (NASDAQ:MSFT) affirms the company’s bona fides in security.
That kind of licensing model will attract investors. But with substantial profitability still a few years out, the question on Wednesday will be how much progress BlackBerry is making – and how much patience investors will have. BB stock actually trades at a 10% premium to the average analyst target. Revenue is declining (in part due to phone outsourcing), and earnings are expected to fall in fiscal 2019.
Even with a clean balance sheet, BlackBerry is back to being a growth stock with a high valuation relative to earnings. With that growth still a couple years away, BlackBerry will have to show investors it will be worth the wait. In this market, and with earnings expected to be roughly breakeven, that means CEO John Chen will have to put on a performance during the post-earnings conference call.
Earnings Reports to Watch: Constellation Brands (STZ)
Earnings Report Date: Thursday, March 29, before market open
Constellation Brands, Inc. (NYSE:STZ, NYSE:STZ.B) has been one of the best performers in the market for some time now. In the past five years, STZ stock has nearly quintupled. Its beer brands like Corona, Modelo and Ballast Point all are posting growth. Margins continue to expand. And the company’s stake in Canada’s Canopy Growth Corp (OTCMKTS:TWJMF) gave it a toehold in the recreational marijuana business as well.
But here, too, valuation might be a concern heading into Thursday’s report. The STZ chart shows a double top around $230, which could prove to be near-term resistance. A 23x+ forward P/E multiple is a reasonably healthy valuation in a beer space that looks challenged by craft beer competition and, potentially, oversupply.
Meanwhile, fiscal Q4 expectations do look reasonably high, with analysts expecting an 18% increase in EPS and a 7%+ rise in sales. Constellation is lapping the divestiture of its Canadian wine business, which should help reported growth figures. Still, investors are looking for a very strong quarter in industries that overall aren’t growing all that strongly at the moment.
More broadly, STZ earnings should give an idea of where the market sees the U.S. consumer at this point. Wall Street is still bullish on STZ, with an average price target just shy of $250. If Constellation can provide the numbers and the outlook to raise those targets, the multi-year run in Constellation Brands stock should continue. But if investors don’t trust the consumers buying Constellation products, even a strong quarter could be for naught.
Hilary Kramer is the editor of GameChangers, Breakout Stocks, High Octane Trader, Absolute Capital Return and Value Authority. She is an accomplished investment specialist and market strategist with more than 25 years of experience in portfolio management, equity research, trading, and risk management. She has extensive expertise in global financial management, asset allocation, investment banking and private equity ventures, and is regularly sought after to provide her analysis on Bloomberg, CNBC, Fox Business Network and other media.
