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When Good Companies Surprise Us With Bad Earnings

Boston Brewing Co

Above is the chart of Boston Brewing Co., showing the strong uptrend that was recently broken. You can see that for the past couple of years, the company has moved up in concert with the 20 and 50 day moving averages. However, on May 5th it surprised everyone by missing its earnings in a big way – the culprit was higher energy prices adding significantly to its transportation costs during the quarter. They affirmed their original full year guidance range, but only because it was a very wide range that gave them lots of wiggle room, so that didn’t pacify investors.

Normally, this would be one of those events that cause us to possibly book the profits we’ve made to date. However, there are three mitigating factors that I believe might cause us to hold onto this company – or potentially add to our current position – and see if their proven management skills can get things back on track:

1. If you look at the chart, there is still a lot of positive investor sentiment with this company based upon the fact that the selloff stopped right at the 200-day moving average. The 200-day moving average is the level at which you want to buy good companies as they tend to move higher if their business is sound and their industry is in favor. If it drops below the 200-day moving average then we will reassess the “buy-the-dip” sentiment of investors.

As far as the business being sound, earnings are growing at 28% per year and they have no debt on their balance sheet. As far as the industry being in favor, most of the beer producers are near 52-week highs in their stock price.

2. If energy costs were the culprit that ate into earnings, we had a $10 per barrel crash in the price of oil yesterday that should translate into a more favorable cost structure for the company.

Much of the oil (and other commodity run up) has been due to speculation so once that is shaken out of the system, fundamentals can take over.

3. In spite of the earnings miss, their earnings growth is still projected to be 28% this year. That is significantly higher than defensive stocks that are growing in the single digits and trading at much higher PEG ratios – this company is trading at a 1.7 PEG ratio while Procter & Gamble is trading at 2.0 PEG with 9.1% earnings growth and Clorox is trading at 2.09 PEG with 7.3% earnings growth.

PEG, if you recall from previous blog posts, is a key to our investment methodology. It a ratio of the P/E ratio to earnings growth rate. What it does is allow you to compare apples to apples: high growth companies can be a good value if their PEG ratio is lower than other companies in slower growing industries – even if their P/E ratio is higher.

One axiom my work has taught me over the years is that a company with a PEG ratio of less than 2 is always a better investment than a company with a PEG ratio greater than two: its always better to have a company valued at less than two times the growth rate than more than two times the growth rate.

So, for now, I am sitting back and waiting – I’m not at the point where I want to add to the position as I’m still monitoring the investor sentiment, but the fundamentals seem sound enough that holding this company that has a proven and battle tested management makes sense until we see if the fundamentals change.

Enjoy the weekend!

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