Friday Fallout – Google and Microsoft Disappoint, ISRG Melts Away

3 major companies had big disappointments yesterday yet the broad market, so far, seems strangely unaffected.  Let's tackle them one at a time:   ISRG fell from $420 to $355 (15%) overnight – and that's just 2 weeks after they fell from $500 to $420 (16%) on a warning they would miss earnings.  Revenues were up 7.8% from last year but earnings were $3.90 per share vs $4.04 expected.  What really shot the company down was the negative outlook for next quarter ($4.02 vs $4.24) and that's dragged the full-year guidance down to $17.25, from $17.65 (2.2%!).  

If WT & F spring to mind looking at these numbers, you are not alone.  The REAL issue is the already anticipated warning letter from the FDA, which has asked the company to resolve 2 issues found during an inspection but, in truth, they relate to reporting issues, company in some cases hadn’t adequately reported device corrections and patient adverse events.  This is, of course, being spun as somehow nefarious by the short sellers and their media hounds but, chances are, it will be addressed quickly and soon forgotten.  

So we like ISRG for a long-term play and you should be able to take a poke at them by selling 2015 $300 puts for about $35 for a net entry at $265.  This is similar to the way we played AAPL when they fell below $400 and you have to be ready, willing AND able to have the stock assigned to you at net $265 and you have to be looking to establish a LONG-TERM position because the stock may fall further – this is simply a value prediction over the next 18 months.  

You can also take a margin-less poke at the company buy buying the 2015 $300 calls and selling the $360 calls for about $30 and that trade is simply a bet that they ultimately hold $360 and you are tying up $30 for 18 months in hopes of making $30 more – not too bad since you are starting out $60 in the money.  Combining that spread with the sale of the $300 puts for $35 gives you a net credit of $5 with a $65 upside at $360 and the worst case is you own 500 shares of ISRG for $295 ($29,500, or about $14,750 in ordinary margin)  That's one I'd like to add 2 of to our Income Porfolio, in fact, for a possible $13,000 gain!

Moving on to MSFT, now.  Is Ballmer still CEO?  Well, then they suck, get out.  

Now, on to Google, who missed expectations of earning $10.78 by a whopping $1.22 (11.3%), coming in at $9.56 with essentially in-line revenues at $11.1Bn (off by "just" $230M).  After a wild ride from $910 to $858 in the Futures last night, they've come back to $880 pre-market, down just 3% on an 11% miss – it's a miracle!!!

Well a manipulacle, in any case.  GOOG's fall was a serious threat to the Nasdaq holding 3,600 at expiration so it needed to be correced, ISRG did not.   BMO Capital Markets, JP Morgan, Deutsche Bank and Raymond James cut their price targets on Google's stock by as much as $40 to factor in a drop in margins as the company invests in its non-core businesses.  "… Investors should assume continued margin erosion as new investments will never match the margins of the core search business," BMO analysts said in a note to clients.  

So, like AMZN, GOOG is forgiven all sins in eagar anticipation of all investments paying off down the road but, unlike AMZN, GOOG has actual profits so it's a little scary when they go down.  Amazon wisely avoids this problem by never actually having any profits so, when they announce losses for the quarter – their stock goes rocketing higher.  Google has a long, hard road ahead of them to get to losses but, hopefully, one day they can achieve them and perhaps get a nice 100x forward earnings valuation like AMZN and be worth about $5,000 a share!  

So we can't bet against Google (we were already short in our Long-Term Portfolio) but we're not going to bet on them either although, if they do have an unrealistic recovery, it may be fun to play them short on either the daily or next weekly puts – on the off chance they fall back out of favor into the close or over the weekend. 

Speaking of valuations, AAPL also makes about $11 a quarter, per share but they have a p/e of 10 on their 940M shares (maybe less as they are buying them back) while GOOG has a p/e of 27 on their 270M shares.  If GOOG is being forgiven these earnings – let's hope investors are so forgiving with AAPL next week and we'll be seeing $500 again! 

As noted by Gizmodo above, there is a war going on for your eyeballs and, as you can tell from a visit to any App Store, there are thousands of companies vying for your attention and, generally, we have our 3 major battlefield generals who are locked in mortal combat.  Frankly, the only company that has a sensible valuation in the group is AAPL, with a p/e of 10, they are priced like a commodity provider because, ultimately, that what all of these guys will end up being.  

Pricing GOOG at 27 times earnings and MSFT at 20 times earnings assumes a growth outlook that's just not very likely – and we're not even considering the fact that a 4th party may enter the fray at some point.  Before Google there was Netscape and Alta-Vista and AOL (who reinvented themselves as a publisher) and before Microsoft there were IBM, Sun, Accent, Unix, etc. and before AAPL there were toasters, and they were fun to watch too!  

Overall, these are the kind of earnings reports we were expecting – there was no way, in this macro environment, that companies were going to be able to live up to the ridiculous expectations that have propelled this market to all-time highs.  As I said to our Members as we topped out yesterday and we pressed our short bets – it's gut-check time.  

We'll find out next week if the markets can overcome weak earnings and keep going higher but today is expiration day – anything can happen, and usually does!  

Have a great weekend, 

- Phil