Foolish Four Portfolio
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Consensus estimates had been in the neighborhood of $0.97 for this quarter and $2.96 for the year. Third-quarter earnings were only $0.61 and last year's fourth-quarter earnings were $0.87, so it looks like earnings will be at least 30% below expectations and at least 20% below the comparable quarter last year. Not good.
When I read the news I was surprised that the drop was only $6.75 a share. Can you imagine what would happen if a "hot" stock announced a 30% drop in earnings? Look out below! As it is, Caterpillar dropped 12% and bounced back 2.3% today.
The headline above, by the way, comes from the old Wall Street saying: Even a dead cat will bounce once if it falls far enough.
That's not literally true, although I suspect it might depend on how long the cat had been dead and the general condition of the body. But let's not go there. The point is that conventional wisdom says that after a major drop, there will be investors looking for bargains who will cause the price to bounce up a bit -- temporarily -- no matter how bad the prospects for the company may be.
(That strikes me as one of those truisms that is true often enough to get noticed, but not often enough for anyone to actually make money from it. Still, lots of investors make a practice of buying stocks that suffer big one-day drops, hoping to catch the bounce.)
Caterpillar is hardly dead, of course. The company took pains to say that the slump in North American sales that was causing the earnings shortfall was expected to be of short duration, and most analysts seem to agree. Earnings estimates for this year (since this is the last quarter) were revised downward, but expectations for 2000 remain unchanged.
So now Caterpillar, once the star of the portfolio, is our only stock that is losing to the market (IP is losing to the Dow but still beating the S&P 500). This is understandably disappointing, especially to those who may have entertained the idea of selling last April when the stock was up more than 40% after a fantastic first-quarter earnings report. But that's another place you don't want to go.
One of the most difficult things to deal with in making the transition from a backtested strategy to a real-life portfolio is how things play out day to day. It's all well and good to have backtested returns that show wonderful yearly gains almost every year. It's quite another to watch those gains in real time and see how they rise and fall.
Stocks don't go up in an orderly fashion. Those annual returns over in the Statistics Center don't show you the dips and peaks, and they tell you absolutely nothing about whether or not a stock traded higher at some point during the year. Inevitably, many will have done so.
A number of strategies have been tested in an attempt to improve on the simplistic "hold for one year" rule, but so far no one has come up with a way to improve on the overall, long-term returns by, say, selling when a stock is up over X%, or selling if it drops X%, or selling if it drops off the Foolish Four list (that one is totally counterproductive, actually). I'm not saying that there isn't such a rule, but we sure haven't found it yet.
If you are tempted to try your hand at calling the peaks, remember this: If you had sold Caterpillar last year at its high, you would very likely have replaced it with Sears, which was the top Foolish Four stock at that time.
But the real lesson here is that unless you are truly gifted when it comes to stock picking, you will most likely be better off following the rules -- even if they sometimes hurt.
Fool on and prosper!