Beware Your High Expectation Stocks: Freshii Gets Stinky!

Date Added: September 28, 2017 | Comments (0) | Filed under: Blog

From the Globe and Mail.  Couldn’t agree more.  As long as this kind of thing happens the future is bright for value investors and short sellers.  Beware your high expectation stocks!

As Freshii stock goes sour, it may be time to detox from analyst advice

IAN MCGUGAN

18 HOURS AGO

SEPTEMBER 27, 2017

FOR SUBSCRIBERS

The problem with gobbling up Freshii Inc. stock is that a few months later you’re hungry for answers.

How is it that a tiny fast-food chain specializing in healthy meals can go public at the end of January, raise $125-million from investors based on its projections of warp-speed growth, earn near-universal applause from analysts – and then abruptly scale back its growth projections in September, chopping its share price and costing initial buyers a bundle?

The stock’s erratic journey from $11.50 at the end of January to around $5.70 today is a sad and odoriferous demonstration of how Bay Street operates. Among other surprises, Freshii has slashed its forecast for this fiscal year to include fewer than 95 net new outlets, a giant retreat from its previous forecast of more than 150. Apparently, the outlook for veggie bowls and black-bean-and-avocado wraps has shifted massively in less than eight months.

“Today’s announcement is extremely disappointing to me,” chief executive Matthew Corrin said in a prerecorded apologia on Monday. Yep, although one might add that it’s not nearly as disappointing to him as it was to people who entrusted him with their money in January.

But let’s cut Mr. Corrin some slack here. Freshii is his baby and he no doubt suffers from an all-too-human inclination to brag about its potential. What really smells is the willingness of underwriters and analysts to uncritically accept his positive outlook.

Back in February, six out of seven analysts following the stock rated it a “buy” with only a single “hold” recommendation. Earlier this month, kale-induced euphoria still reigned supreme: Seven out of nine analysts called the stock a “buy.” It was only after this week’s giant step back by management that a sterner tone took hold. Today, only four out of 10 analysts term Freshii a “buy” with the remainder insisting it’s a “hold.”

If there’s a lesson to be gleaned from the Freshii debacle, it’s that analysts’ rankings should be taken with a massive grain of salt (or, in the case of Freshii, a low-sodium equivalent).

It’s not a new lesson, but it’s one driven home by both the Freshii example and a new working paper from Pedro Bordalo of the University of Oxford, Nicola Gennaioli of Universita Bocconi, Rafael La Porta of Brown University and Andrei Shleifer of Harvard. Among many fascinating findings, their work, titled Diagnostic Expectations and Stock Returns, examines the track record of expert forecasts.

Their research shows the stocks that analysts love produce generally miserable returns. Conversely, the stocks loathed by analysts tend to generate double-digit payoffs.

The size of the discrepancy is striking. Between 1981 and 2015, the 10 per cent of U.S. stocks with the highest forecasts from analysts for long-term growth in earnings per share earned an average return of only 3 per cent over the subsequent year. Meanwhile, the 10 per cent of stocks with the lowest forecasts generated a 15-per-cent return.

Value investors will tell you this reversal is rooted in behavioural factors and can be exploited to generate big returns. Perhaps so, although buying unloved stocks takes a discerning eye and a strong stomach.

What is beyond dispute, however, is that investors should be cautious about stocks that earn raves from analysts. It’s difficult, as a rule, to earn big returns from stocks that everyone loves. Big expectations are already built into the share prices of these adored businesses and it’s hard for any company to consistently exceed those lofty hopes. (Even after its big drop, Freshii sports a market capitalization of $174-million – which is rather a lot for a business that’s expected to earn about $7.5-million next year.)

The tendency for expectations to run ahead of reality is particularly marked in the case of initial public offerings (IPOs), when some analysts may feel the need to support recent underwritings with the most positive possible coverage.

Retail investors need to be cautious. Just as with Freshii, other recent Canadian IPOs, such as those of parka maker Canada Goose Holdings Inc. and vitamin seller Jamieson Wellness Inc., play to an interest in trendy, lifestyle products.

Canada Goose and Jamieson are now being cheered on by enthusiastic analysts. Both companies may go on to delight their shareholders. But if there’s a moral to be gleaned from the Freshii tale, it’s that you should balance your diet of optimism with a willingness to be skeptical of the boosters on Bay Street.


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