First, let’s agree that the reaction to the headlines is not always representative of a bad report. Therefore, we wouldn’t be scraping the bottom of the barrel. Often dislocations occur because of questionable estimates and/or expectations.
To simply make that point, consider that very rarely do the biggest companies deliver bad reports. Yet, about half of the moves are down on the headlines. The human element is impossible to forecast for the knee-jerk reaction. The results matter long term and this is part of the thesis today.
When quality mega-cap stock fall because of emotions or sentiment, smart money pounces. I like to take advantage of others’ weak moments. Not every falling knife deserves catching, but today’s picks are of great quality. The odds are in our favor for the next few months. Nevertheless, there are extrinsic factors, so we should taper our enthusiasm.
The stock markets are breaking records with a lot of artificial help. This means that they are vulnerable to surprise hiccups. It won’t take much to shake the bulls’ psyche. They will be quick to hit the sell button. A preview of it happened yesterday during the question-and-answer session of the Federal Reserve conference. Chairman Jerome Powell simply mentioned the word “froth” and it triggered giant red candles.
This is all to say that I am optimistic, but we should be cautious as well. Instead of taking a full-size position, investors should enter trades in tranches.
The three mega-cap stocks to buy this week are:
Mega-Cap Stocks: Microsoft (MSFT)
Microsoft is part of the OG mega-cap stocks posse. Then it faded into boredom until the current CEO Satya Nadella took it over. He completely transformed the company and adapted it to the new tech subscription model. It is now a thriving business and has a strong position owning the cloud. Amazon (NASDAQ:AMZN) is still the leader there, MSFT is a close second. This is important to our thesis today because of the digital revolution.
The novel coronavirus pandemic accelerated the rush to the cloud. Companies and even individuals are now rushing to get there. Demand for that has exploded and that’s not a fad. The trend is growing and has a long runway. It’s a big world and we are still in the early stages of it. Hardware is getting better and faster to fill the need. This plays right into Microsoft’s strategies.
This week, the company reported a very strong quarter. They grew earnings by 40% and sales by 19%. As a reward, investors sold it down on the headline. Management, in fact, beat their forecasts but that wasn’t enough. Investor sentiment was the driving factor for selling the stock. There was nothing wrong with the report and management over-delivered on all of its promises.
This is a classic example of an opportunity to take advantage of someone else’s mistake. At this point, it is important to mention that there could be two more days of selling. MSFT stock could indeed fall toward $248 per share. That would make an even better starting point for the summer. Those who know options can start selling puts below those levels. It is unfair is to judge a winning company harshly just because of unrealistic expectations.
Much like Zoom (NASDAQ:ZM) became a verb, Pinterest business grew a lot because of the pandemic. The fact that the whole world was out of work brought a lot of attention to its platform. The stock fell 15% yesterday on its earnings headlines. Judging by that, one would guess that they missed on estimates and that delivered bad numbers.
This wasn’t the case because they, in fact, beat the sales and earnings estimates. Earnings grew +210% and sales +78% from this time last year. Clearly they passed with flying colors, but the investors wanted more. It is wrong to punish a stock almost 15% on a very strong quarter. Therein lies an opportunity to catch the falling knife.
First, we acknowledge that PINS stock moves fast, so this may not be a one-day event. The selling could persist this week and challenge the prior bounce levels from March 5. Buying the stock into that weakness makes sense but not all at once. It should yield profits by the summer.
Value is potentially an issue. They still lose money and they have a high price-to-sales. This puts pressure on management to keep delivering growth. It’s a competitive field so they have to stay relevant. So far, there are no worrisome signs but the critics will be watching.
It is also important to realize that there could be another trap door lurking. If, for whatever reason, the stock falls below $60 per share, it could trigger a bearish pattern for another $8. This is an improbable scenario in my book, but I have to acknowledge it’s there.
Mega-Cap Stocks: Fastly (FSLY)
Fastly is my last pick for the day and it could be the wildest of them. At $8 billion it is not quite part of the mega-cap stocks category yet. But I will include it here because it punches above its weight. Earnings are coming up so that leaves a huge question mark for the next two weeks. I say this because when they reported earnings last quarter, the stock collapsed more than 30%. This was just after it had already fallen more than 20%. Clearly, FSLY stock moves at blinding speeds and it’s not for the faint of heart.
I started today’s by saying that the reaction to earnings is arbitrary. This by definition makes this third pick the weakest conviction of the three. Microsoft and Pinterest stocks have already reacted to the earnings. Now they can recover and trade on merit. In this case, I am betting that the investors will have an opposite reaction the last time. Therefore, I consider this a lottery ticket so it should be small in size. It must not break my piggy bank and it is OK to break my heart.
Headlines aside, the price action in FSLY stock is tightening. The bulls have established a small higher-low trend. But they are also struggling against a zone of resistance. Management will have the opportunity to give the fans the push they need to break out. The upside potential could be big. Conversely much like Pinterest, it needs to hold the base. If FSLY falls below $58 per share it’s going for a ride lower.
Fundamentally, the business has a great opportunity. They are at the heart of the new strong trends. They help deliver online content and that’s where the whole world is going. The migration from old media to new also has a long ramp ahead. The scope of the market is massive so all the providers will prosper for years. FSLY stock is not cheap with a 27 price-to-sales, but it’s not a problem yet. Management is delivering growth for now and that earns them a pass on that front. Their revenues nearly tripled in four years.
On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Nicolas Chahine is the managing director of SellSpreads.com.