24 stocks that could fall after profits

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ViacomCBS meets the criteria for stocks that could experience a dramatic drop the day after their earnings are released.

Tiffany Hagler Gear / Bloomberg

The second quarter earnings season kicked off this week with the big banks in the lead. But even with a booming economy and many stocks at or near record highs, there are still risks lurking for investors.

One such risk is profit explosion (when a stock drops significantly the day after it is declared). Stock in the electric vehicle pioneer You’re here (ticker: TSLA), for example, fell around 4.5% after reporting better-than-expected first quarter earnings in April. The problem, however, was that the profits were in part due to a one-time gain on the company’s Bitcoin position.

To avoid these situations, investors may want to avoid companies with below average earnings quality, or earnings that are boosted by factors other than improving the core business.

Companies with relatively low earnings quality metrics are not necessarily trying to fool anyone. But earnings reporting is only about expectations, and poor earnings quality can be a warning sign.

Chris Senyek, accounting and tax policy expert at Wolfe Research, ranks companies from 0 to 100 based on the quality of their earnings and compares companies within industries against each other. A low income score can be due to a combination of factors. Often, non-cash fees, which include one-time earnings, don’t repeat themselves, skewing the digits by a quarter. Increasing levels of working capital, which includes items such as inventory, can mean that earnings and cash flow are unrelated. Other accounting factors, including lower than expected tax rates and one-off adjustments, may contribute to a lower quality score.

Senyek examines many other factors to generate his scores. He recently identified 10 companies that have experienced a change of CFO or recent mergers and acquisitions, which can generate unexpected earnings volatility and score low on earnings quality compared to their peers.

His list of 10 stocks to avoid this quarter includes the installation contractor

Construction products installed

(IBP), manufacturer of contact lenses

Cooper companies

(COO), healthcare company

First

(PINC), defense supplier

Mercury systems

(MRCY),

Equifax

(EFX), manufacturer of industrial components

Rexnord

(RNX), software provider

Coupa software

(STROKE),

Photocopy

(XRX), T-Mobile US (TMUS) and

Lululemon

(LULU).

Senyek also recommends that investors avoid companies with low earnings quality and high short interest, or the amount of stocks borrowed and sold short by bearish investors betting on price drops relative to the total amount of the total. shares available for trading. This is because bearish investors expect something bad to happen with the stock and earnings are usually the catalyst.

Large stocks that meet its criteria for lower earnings quality and higher short interest relative to a company’s peer group are

Network of dishes

(DISH),

ViacomCBS

(VIAC),

Sirus XM

(SIRI),

Carvana

(CVNA),

Catering equipment

(DR),

Expedia

(EXPE),

Wayfair

(W),

Boston beer

(SAT),

Kellogg

(K),

Baker Hugues

(BKR),

BioMarin Pharmaceutical

(BMRN),

Lyft

(LYFT), software provider

RingCentral

(RNG) and home decking company

Trex

(TREX).

The average short-term interest of this group is around 11%. That’s about five times the average short-term interest for

S&P 500

actions.

While there is no guarantee that stocks will go down when these companies report earnings, Senyek believes the risk of a profit explosion is high. Investors may want to look beyond the overall earnings numbers with these two dozen stocks.

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