Ahead of Themselves

While it’s true you own a stock for where it’s going rather than where it’s been, there’s an important footnote to the axiom….. the stock’s price still has to make sense, whether you’re looking forward or looking backward. That reality seems to have forgotten in a few cases during this earnings season, as investors have been blown-away by some huge year-over-year increases.

Just to reel in some of the ‘big number’ euphoria, here’s a look at some stocks that have made a little too much price progress relative to earnings progress.

Setting the bar low: Yes, Goldman Sachs’ (GS) income was up 91% in Q1 of 2010 versus Q1 of 2009. That $3.3 billion earned, however, was actually ‘just average’ relative the last three quarters of 2009. Remember, equity underwriting didn’t get unusually better last quarter – it was unusually bad in the first quarter of 2009.

Moreover, the $18.27 per share Goldman is expected to earn in 2010 still pales in comparison to 2007’s $24.73. So, investors who see GS as undervalued relative to its history should know that Goldman Sachs shares are actually more expensive now, looking ahead, than they were then.

Why now?: Before celebrating TD Ameritrade’s (AMTD) big earnings win of $0.27 per share last quarter – ahead of the expected $0.24 – you should know that it was a one-time tax gain what pushed them into the ‘progress’ column. On an operating basis, the brokerage firm only earned $0.23 per share…. the same as the first quarter of 2009.

This was the second shortfall in a row, and at its current rate of earnings growth, TD Ameritrade will make less in 2010 than it did in 2009. In fact, the company’s likely to earn about 25% less in 2010 than it did in 2008, yet AMTD is currently priced roughly twice what it was trading at in late 2008.

Priced for a full recovery, and then some: Hasbro Inc. (HAS) wowed investors by topping earning estimates for last quarter by 62%, and nearly tripling income levels from the same quarter a year earlier. What the company didn’t mention was that the first quarter of 2009 was the worst quarter since early 2007 – it would have been tough not to do significantly better. The second quarter’s numbers aren’t expected to top Q2’s from 2009.

Meanwhile, HAS shares are back at near-record-high P/E levels on assumptions that 2010 will yield stronger income than 2007 or 2008 did. It’s possible, but a long shot.

Similarly, toymaker Mattel’s (MAT) share price has more than doubled over the last twelve months on assumptions that 2010 will produce 31% more income than 2009 did. Can earnings be better? Sure, especially considering the company just walloped Q1-2009’s earnings in the first quarter of 2010. Can they actually be 31% better, and top 2007’s earnings though? That remains to be seen.

[Side note: In five of the eight quarters that made up 2007 and 2008, Mattel actually fell short of EPS estimates. So, 2010’s lofty goals are a tad dubious.]

Right idea, but dangerous expectations: While growth – regardless of from where to where – is what all investors should seek, it’s not the only piece of the puzzle.

The idea of reasonable valuations [even on a forward-looking basis] is the other piece of that puzzle, but it’s fallen by the wayside this earnings season so far. That euphoria may even last for a while longer, but eventually, the actual and absolute earnings numbers will need to justify the stock’s price. Some companies will be able to do so, but it’ll be tough to do in too many cases once investors realize some stocks are priced for results well beyond 2007’s and 2008’s.