For many investors, earnings season is buying season. As each round of earnings brings news of “positive earnings surprises,” these investors find courage in the good news, and are convinced to climb aboard.
So when Goodyear Tire & Rubber Co, reported “upbeat results” and made analysts look a bit foolish for particularly bearish forecasts, the stock staged a vigorous rally. Shares of Goodyear Tire & Rubber Co. gained more than 14 percent earlier this month after the nation’s largest tire maker reported fourth-quarter results. By the close that day, the stock was looking at a year-to-date increase of nearly 20 percent.
Because Goodyear “represents a major brand name” — and because the stock started moving before its earnings came out — the good news had investors making their bullish case.
As happens with so many stocks where the buying motivation comes from quarterly headlines and an earnings surprise, however, the strong uptick and promising news masks the issues that make Goodyear the Stupid Investment of the Week.
The basic case for Goodyear was that the iconic tire manufacturer has been cutting costs, sometimes by outsourcing production and streamlining operations. Tires are not completely recession-proof, but consumers can only put off buying new ones for so long and any time there is a weakness in sales — as the entire industry has seen of late — it typically is followed by a rally in sales.
Perhaps because of its reputation — or its blimp and other advertising – Goodyear has been able to do a good job of holding onto market share while it was doubling its average prices, focusing on premium tires. In December and January, some prominent analysts upgraded their outlook on Goodyear, and the stock rallied.
The news that kicked things into higher gear this week centered on a “positive earnings surprise,” meaning the stock did a lot better than analysts predicted. Where the average forecast was for a quarterly loss of seven cents per share, Goodyear — excluding several one-time items — posted a fourth-quarter profit of 7 cents per share.
Sales were up, and Richard Kramer, Goodyear’s CEO, said he expects “significant momentum” to carry the company through the rest of the year.
Just as analyst forecasts vary, so do estimates of Goodyear’s fair value, but most observers seem to think the stock is close to or slightly below a fair-market price, which would mean that it’s a bit of a bargain, even after the run-up.
Put it all together and it seems to be the perfect case for letting an earnings surprise drive an investment purchase.
The problem is that all of those signals are on the surface, and with just a little bit of digging it becomes clear that Goodyear has a lot more downside risk than upside potential.
For starters, if you don’t adjust the operating results for one-time items, Goodyear’s fourth-quarter profit turns into a loss of $177 million, or 73 cents per share. That would suggest that analysts who were expecting a loss misunderstood the one-time events. In 2009, Goodyear posted a profit of $107 million, 44 cents per share, for the fourth quarter.
Goodyear’s union contracts will make it hard to drop prices or consolidate more plants in North America, and while sales are likely to increase, the company said it expects raw materials costs to jump by as much as 30 percent this year. That would put more pressure on consumers to keep costs down, which could erode Goodyear’s overall market share as premium tires give up ground to lower-cost imports.
Then there is the company’s enormous debt load and pension obligations. The company’s debt-to-equity ratio is north of 600 percent. The price-to-tangible-book-value is above 600, too.
Those levels hint that the company’s ultimate destination could be bankruptcy. At the very least, they mean that any bad news could crash Goodyear’s blimp as if it was the Hindenburg.
“Everyone says ‘Oh, but it’s Goodyear, and they make tires and people always need tires. And look at the brand name, and the blimp,’” said Brent Wilsey of Wilsey Asset Management in San Diego. “How can you expect the company to compete in an environment where it is losing money and has a horrible balance sheet? People may think they are getting something great, but they’re being fooled by all of the traders who want to make quick-hit profits here. Those people are driving the price up, and when things settle down it will be the average guy who got fooled.”
In the end, that’s why positive earnings surprises are not always so positive for ordinary investors. While they make headlines, they also take investors’ focus away from what matters, which is the story that is told by the underlying numbers rather than the tale told by industry analysts.
Said Wilsey: “For the average investor, an earnings surprise doesn’t matter, and the real numbers do. You’re not getting something great just because the analysts didn’t have a great read on it, and because the media is running with that headline. ... Goodyear proves that.”
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