Short setbacks can be bargains

Q: If stock price falls after earnings, is it time to buy?

A: The short answer is that it depends why the company’s quarterly report caused the share price to drop.

If something fundamentally changed with the business that could become a long-term issue, such as a slowing growth rate, intensifying competition or declining sales, then that share price drop could be justified.

One example that immediately comes to mind is Starbucks. The coffee chain’s same-store sales growth missed expectations by a wide margin due to challenges that have been cutting into its store traffic since last year. Those factors indicate that its growth could be slower than had been anticipated. I’m not saying Starbucks is a bad stock to own — I’m saying that slowing growth could be a long-term issue.

On the other hand, Facebook reported an excellent quarter, but its share price dropped because CEO Mark Zuckerberg said his company will dramatically ramp up spending next year to prevent the abuse of its platform.

Although this will cut into profitability, the impact is likely to be temporary. In other words, the company’ growth story is alive and well — even if for the time being expenses will grow faster than sales.

Bottom line: It’s important to distinguish between a temporary setback and a lingering change to a company’s business when digesting an earnings report. Temporary setbacks are the situations that tend to produce bargains.