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Expectations vs. Reality

Written by Briton Ryle
Posted October 2, 2017 at 7:30PM

It always starts off innocently enough...

You think, "Eh, maybe they can step up and perform well enough over the next couple of quarters."

And then you see some anecdotal evidence that things really are getting off to a pretty good start, and the optimism starts setting in. 

"Hey, maybe these guys are doing a lot better than I thought."

Then you get a day like yesterday...

Yeah, sorry, not talking stocks here. Not yet, anyway. I was sitting in the stands yesterday as the Baltimore Ravens hosted their archnemesis Pittsburgh Steelers in a game to decide the early leader in the AFC North. Even after last week's utter debacle in London, where the Ravens got trounced by the Jacksonville Jaguars 44–7, I really, honestly, truly thought the Ravens would prove themselves the better football team yesterday. 

I found it pretty easy to write off the London game. The team flew out of Baltimore on Thursday for the Sunday game at Wembley Stadium. That is just a bad move. There's no time to adjust for jet lag and do some sightseeing, which you know players are gonna want to do. Most teams scheduled to play a London football game fly out Sunday night or Monday so they have plenty of time to get acclimated. Oh, but the Ravens' egomaniacal coach Harbaugh knew better...

A bounce back seemed likely against the Steelers. Wrong. Very, very wrong.

It is now clear that the Baltimore Ravens football team has serious, fundamental flaws. The 2017–18 season is basically over before it even got started. This not a team you want to "buy low" on.

Fool Me Once...

I may be pulling the plug on the Ravens a little early. But I'm not going down with this sinking ship. Maybe I will catch a little of next week's game on TV. I won't be investing a full four hours to watch the whole thing, and I certainly won't be plunking down a couple hundred bucks to go to the game. 

If the Ravens were a stock, it'd be time to "sell, sell, sell!"

When you invest in a stock, it's not that different from getting on board with your local sports team. You scout the personnel. You assess the game plan. You get a read on the competition. You outline your expectations. And then you watch carefully to see if your expectations are being met. 

Every three months, companies give us a very clear progress report. It's called quarterly earnings. And the nice thing about investing is you can lean on the smartest people in the world to help you craft your expectations for a company.

For instance, there are 30 analysts publishing their expectations for Apple (NASDAQ: AAPL). There are hundreds of fund managers buying or selling Apple stock. MIT grads are designing chips to make the iPhone work. Technology nerds break down the components of the latest iPhone. 

And all these people will tell you how many phones they think the company will sell. They'll tell you how much money they think Apple will make. They'll tell you what new features are coming, how good the camera is. They'll go to the stores and see how busy they are. They'll check the newest app sales, and on and on. 

There is so much information on Apple out there in Internet-land that it is truly mind-boggling. Performance expectations are spelled out in no uncertain terms. And so it is very easy to quickly tell if Apple (or any other company) is meeting — or missing — those expectations. 

I'm sure I don't have to tell you what happens when a company misses expectations. Miss earnings, and your stock will get crushed. 10%, 20% — investors will just about always sell first and ask questions later. 

I often see or read people say that reactions to a miss are overblown. That investors are dishing out undue punishment to a company that had a little problem...

This view is usually wrong. Most times, selling first and asking questions later is exactly the right thing to do. Because when you have so many people digging so deep into so many performance metrics, they aren't missing much. And if Apple itself comes up short on some important number, it is highly likely that the problem is big and won't be fixed by the time the next earnings report rolls around.

Case in point: Costco (NASDAQ: COST). Remember when Amazon bought Whole Foods and every grocery store tanked? Well, Costco had basically been top dog in the space for years. The stock was a thing of beauty, from $50 to $180 since 2010. It basically never missed on anything. It was the only company that could legitimately challenge both Amazon and Wal-Mart. Then Amazon grabbed Whole Foods, and Costco dropped from $180 to $167 overnight. And it kept going, down to $157. 

It was around that price that analysts started saying the sell-off was overdone. Investors were unfairly punishing the stock. Costco's membership model was immune to Amazon/Wal-Mart. Sounded good. The stock went lower, to $151. It rallied a little, fell back to $151. Today, it's at $166. It's a good thing COST beat earnings last quarter, too, or it wouldn't be anywhere near $166. 

Costco didn't do anything wrong. It didn't miss earnings. But expectations are now different on a fundamental level. And, like I said earlier, that just doesn't change quickly. I could have saved myself a couple hundred bucks and the painful throbbing in my temples today if I had just recognized the truth of the Ravens' performance in London last week. The team is fundamentally flawed.

Fixing the Flaw

Now, I wanna tell you about a company that is on the verge of fixing its fundamental flaw. Back in 2015, it traded as high as $120. The fundamental flaw was revealed, and the stock fell as low as $85. It's now trading just under $100.

After a couple years of excuses, downplaying, and ignoring, the fundamental flaw is getting fixed. Over the next six months or so, expectations for this company are going to change for the better. And that could be worth a 40% run for the stock. 

I'm talking about Disney (NYSE: DIS). The fundamental flaw is ESPN and its reliance on cable TV revenue. As we all know, the cord-cutting phenomenon has cost ESPN about 1 million subscribers a year, with no end in sight. 

So, next year, Disney will launch its own streaming service for its blockbuster movies and, you guessed it, ESPN. 

This has the potential to be a game-changing move. Maybe Disney partners with Netflix. Maybe HBO. Maybe they go it alone. But here's the thing: content is always king. And Disney's got the content.

See if you can get shares of Disney stock around $95 before the end of the year. I can see $135 a share next year, no prob. Maybe the Ravens will have a decent offensive line by then...

Until next time,

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Briton Ryle

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An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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