Tuesday, July 13, 2010

All Aboard! CSX Prompts 6th Straight Day of Gains

This is what earnings season is all about.

Investors and traders have waited patiently through two months of severe selling for days in which stocks could outshine a slew of negative economic reports, and it appears - for some, at least - that the waiting is finally paying off.

Stocks surged for the 6th straight session after rail operator, CXS reported strong earnings after Monday's close, citing net income gains of 36% in the second quarter, beating analysts' expectations. Revenue grew 22% to just below $2.7 billion.

Despite the strong report, shares of CSX were lower by about 1.5% on Tuesday, but the upbeat sentiment associated with the company, which hauls coal and countless other raw materials, parts and integrated supplies across the United States, gave traders confidence to bid a wide array of stocks higher.

Dow 10,363.02, +146.75 (1.44%)
NASDAQ 2,242.03, +43.67 (1.99%)
S&P 500 1,095.34, +16.59 (1.54%)
NYSE Composite 6,907.78, +113.30 (1.67%)

Gains were solid across all of the indices and internals were in line with the headline numbers. Advancing issues pummeled decliners, 5486-1025 (5:1), and new highs soared past new lows, 179-48. Volume, however, was not particularly strong, as reticence among potential stock purchasers remained high.

NASDAQ Volume 2,140,849,750
NYSE Volume 5,288,201,500

Commodities trended mostly higher on the day. Crude oil, on the August futures contract, rose $2.20, to $77.15. Gold gained $14.80, to $1,213.30, while silver was up 34 cents, to $18.24.

Announcements after the close on Tuesday were forthcoming from two important companies in vastly different sectors: Intel (INTC) and Yum Brands (YUM).

Intel achieved a smashing success in the second quarter, the best ever in the company's 41-year history, with gross revenue of $10.8 billion, 67% gross margins, operating Income of $4.0 billion, net Income of $2.9 billion and EPS at 51 cents.

The results were well ahead of Street estimates, and completely overturned year-over-year results. For instance, the 51 cent EPS was 183% better than the second quarter of 2009. The company also was very positive about the remainder of the year, with growth expected across all business units.

Stock players were impressed, as shares rose more than 5% in after-hours trading.

When YUM Brands (YUM), owners of KFC, Taco Bell and Pizza Hut, reported second quarter results, sentiment turned decidedly negative. The company beat analyst estimates narrowly, posting EPS of 58 cents, 3 cents better than the 55 cents anticipated, but revised its full-year forecast to $2.43 a share, with Wall Street expectations at $2.48.

This sent the stock tumbling more than 3% in after-hours trading.

These two bellwether stocks demonstrate the cross-currents in the markets quite adequately. While general economic reports - especially those concerning housing and employment - remain a drag on the economy, companies insist that they are lean and profitable, as shown by the results from YUM Brands and Intel.

What is a conundrum for many, however, is the multiple, or PE at which specific companies are trading. Across the S&P 500, the current cumulative PE is about 15, historically high. Intel is right on that number, including this quarter, at 14.45. YUM's trailing PE (using the most recent past four quarters) is an astronomical 19.22.

In other words, it would take 19 years to recoup an investment in YUM Brands based on earnings per share, and just shy of 15 to break even in Intel. In an economic environment beset with an overburden of debt still growing (government) and some being worked off in the private sector, investors may not feel comfortable with such high multiples. That will keep sentiment on the negative side until these multiples come down to levels more in line with the reality of a slow-growing economy. Something in the neighborhood of 9-12 might be suitable, perhaps even lower.

In the small business world, which is arguably more risky, companies rarely sell for more than six times earnings. More often than not, companies sell for three to four times annual earnings, as small business owners seek minimization of risk and quickly recoup their capital. The big business world of Wall Street, operating on a far loftier basis, may be overpriced by a wide degree. Small investors will not stay put in longer term equities with questionable outcomes.

A return to more reasonable valuations would send stocks into a tailspin, though, following on the deflationary backdrop which has been the dominant trend for the past two to three years, a severe correction, on a valuation basis, may be forthcoming.

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