Don't Worry About The Chart; Buy This Stock Anyway

Here we go again. On Tuesday, a company reported Q4 earnings that beat the street expectations in terms of both revenue and profits. That same company also announced a dividend increase and share repurchase program to return around $70 million to shareholders, talked positively about the next year, and revealed that an agreement had been reached with unions that would result in 5 years of labor peace. With all of that good news, the stock reacted in exactly the way that seasoned, cynical observers of the market would expect:

If there were some big, overarching long term existential threat to the company or its business that might make sense, but in this case the company concerned, Kaiser Aluminum (It dropped over 3% in the next two days trading.

(KALU ), is the major U.S. producer of a product that is seeing significant demand growth; aluminum for auto and aerospace manufacturers. In cars and trucks there is a shift to aluminum bodies for greater fuel economy. The new Ford F150 is the best known example of that phenomenon. In aerospace, while defense industry demand has dropped off slightly as U.S. and coalition troops withdraw from Iraq and Afghanistan, that shortfall has more than been replaced by increased commercial aircraft demand as the economic recovery gains momentum.

The only logical reason for that reaction is that one of the biggest problems faced by KALU is maintaining margins, and in that area there was some weakness. KALU is vulnerable to margin reduction for several reasons. Firstly their customer base is, by definition, quite concentrated. There are only so many manufacturers of cars and planes, so those customers have significant power over pricing decisions. Kaiser, as a fabricator of aluminum products, is also vulnerable to fluctuations in price of the commodity. In Q4 margins did fall, but, as the top and bottom line results would indicate, that was more than compensated for by increased production.

That leaves only three explanations for the drop. General market malaise, worry about falling oil prices, and technical analysis. The market has been quiet, but while that might lead to muted reaction to the upside, it doesn’t explain an actual drop in KALU. Even the fact that oil prices are falling again seems like an unlikely reason for KALU trading lower after great numbers. Yes, lower fuel costs decrease the urgency of using lighter aluminum bodies in cars and trucks, but does anybody really believe that oil will stay depressed for long enough to impact the long term plans of car manufacturers? Even if it does, lower jet fuel prices could free up money for airlines to update and expand their fleets, increasing demand there.

That leaves the chart.

You don’t have to be a chart reading genius to see a giant “head and shoulders” pattern in the 1 year chart for KALU. In theory that means that the next move from here is likely to be to the downside. Now, technical gurus have a tendency to get far too technical for any analysis to be of use; if only you can see the “reverse axe and hammer with an inverted aardvark overlay” then it doesn’t mean anything. Something as basic and well known as a head and shoulders pattern, though, can have an impact, simply because it is obvious. If enough people sell based on the pattern, then it becomes a self fulfilling prophecy.

As true as that is, though, over time fundamentals trump any chart pattern, no matter how glaringly obvious it may be. Kaiser Aluminum is the only U.S. manufacturer of a product with growing demand; they are making more money, improving their balance sheet and returning money to shareholders. That, not the chart, is what will drive the price, and those are reasons enough for investors to take advantage of the drop and buy the stock.

By Martin Tillier,

Source: http://www.nasdaq.com/article/dont-worry-about-the-chart-buy-this-stock-anyway-cm446226#ixzz3SnoZVdZB