I generally prefer a contrarian style of trading rather than a momentum-based style; a consensus opinion on a title can sometimes be a self-fulfilling prophecy. If a lot of people think something is going up or down, they will buy or sell it in an attempt to profit from that view, forcing it in the expected direction. It can be a powerful force, but at some point almost everyone has jumped on the bandwagon and there are few buyers or sellers left. When this happens, the stock is vulnerable to a sustained move in the opposite direction should there be some kind of catalyst.
This is what is currently happening with Target (TGT) after the release of its results this morning.
The big-box retailer beat in terms of EPS, with adjusted earnings of $3.19 against estimates of $2.88. They did so on revenue a bit below expectations, which is often a negative in a report but, in this case, is apparently taken as evidence of improved margins, which the street expected from the company. Couple that with expectations of sustained single-digit growth and the stock’s reaction in this morning’s pre-market isn’t exactly surprising, at least in terms of direction:
Still, a 10% rise in a stock on a small pace, a loss of revenue, and a reaffirmation of single-digit growth forecasts is a lot. To understand why this happened, you need to stretch the chart a bit and look at what TGT has been up to over the past four months:
There has been no love for TGT, even though that doesn’t fit the description of the type of stock that conventional wisdom has sold on this drop. They’re growing, sure, but they’re not an ambitious young company that needs to fund more growth and has cash flow or profitability issues. Interest rate hikes won’t hit them hard. They have been making money forever and have a free cash flow of over $5 billion with nearly $6 billion in cash. Target isn’t a high P/E deal either, as it’s trading at just over sixteen times the earnings average after factoring in this morning’s numbers.
And yet, from the November high to the low of a few days ago, TGT has fallen more than 31.5%, much more than the market average during this period. The reason for this, given that it is a solid company with good earnings, is mainly momentum. As the stock fell, analysts began to adjust their views. When the decline really began in December, 25 of 31 Wall Street analysts had an equivalent “Buy” or “Strong Buy” rating on TGT. That number has now dropped to 14. In other words, as TGT has become cheaper and better valued, it has become less desirable according to experts, and the consensus opinion on the stock at the bottom or near the bottom of the decline has turned negative. For the contrarian trader, this is a dream scenario.
After this earnings report, these same analysts will reconsider their pessimism and improve TGT and, in doing so, the momentum will change. As you can see from what happened on the way down, however, the key to profiting from this move is to get involved before all the odds changes happen. Once they do, and TGT again earns near-unanimous “Buy” ratings, it’s time to sell. I’m not hitting analysts here. Their models value “news” that is in the past and it often takes a while to change a stock’s quote or target price. The problem is that by the time they do, conditions have already changed.
There is, in some people’s estimation, an arrogance in contrarian trading. It involves believing one thing, even if everyone says otherwise. If you want to try it, it’s important that you recognize that arrogance and don’t let it turn into stubbornness. It is still necessary to be disciplined on the management of positions. You should set and hold stop loss orders because momentum can go way beyond any logical endpoint. If you do that, however, and especially if you’re expecting the kind of catalyst for a turnaround that TGT had this morning, buying a stock that analysts have a negative view on can be a profitable habit to get into.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.