Six degrees of separation suggests that every person is connected by a degree of six. In other words, take the people that you know and the people that they know, etc. multiplied by six and you would find a connection of some kind.
With respect to analysis of a stock, the market does its own version of six degrees, but instead the depth is usually only two or three degrees. Take any situation and forecast a scenario two or three steps down the road and a conclusion can be reached.
For example, the economy expands, therefore inflation gains traction and prices for commodities rises. The conclusion, then, is that stocks tied to this dynamic will do well.
In reality they did more than just do well. They did fantastic. Anything tied to the inflation trade enjoyed momentum from huge inflows of capital that rode the coattails of an expanding word economy.
Valuations mattered little. The market’s two degrees of analysis said buy no matter what. Well, as they say, what works works until it doesn’t.
One area that really flew during this period was the agriculture space. Huge oil price gains fueled a boom in biofuels. That interest in bio resulted in corn prices going through the roof.
Price increases for corn led to farmer attempts to increase yields feeding demand for fertilizer companies. Those fertilizer companies were inundated with sales that made stocks in the sector high-flyers.
Prior to the boom, Mosaic Co. (MOS) was a sleepy little company trading in the teens in early 2007. When the rocketship took off, investors pushed shares of MOS up to more than $150 per share in mid-2008.
That is one heck of a ride even for a momentum stock. Obviously, such a state was not going to last, and sure enough, the bubble collapsed in July. Oil prices declined, and the original dynamic that fed the inflation trade was flipped upside down.
Now, add in another degree of separation with the economy being hit with a credit crunch and the floor on MOS and other commodity plays was pulled out from under them. Wise investors locked in profits.
To say that selling ensued would be an understatement. Investors fled these stocks like rats jumping from a sinking ship. As a result, MOS lost more than half its value.
And just when you think it couldn’t get worse, it does. On Thursday, MOS announced that it earned $2.65 per share on revenues of $4.32 billion in its fiscal first quarter ending August 31. Analysts had expected a profit of $2.94 and revenue of $4.11 billion.
On its surface, those numbers do not appear that bad. They missed on profits but beat on revenue. Split the difference, right?
Wrong. Investors lobbed off another 40% of value on MOS in one day of trading. Wow, that’s a big cut in a short period of time.
That’s the risk of buying momentum. Easy come easy go. The question now is would you own MOS at these levels?
The answer will take more than one or two degrees of analysis. If you dig a bit deeper, the story may be compelling. If you set your sights a bit lower, to say a double from here, with a longer time frame it may be time to dip your toes into MOS.
Although MOS has been acting like a momentum stock, it really is just a boring defensive stock, and it is that defensive nature whereby owning MOS makes sense.
This article was written by Jamie Dlugosch, contributor to InvestorPlace.com. For more actionable insight like this, go to: www.InvestorPlace.com and check out:
