Put DKS On Your Screen And Watch For A Setup…Here’s Why

• August 18, 2005
• Thomas Neuhaus

On Tuesday, the S&P 500 Equal Weighted, S&P 600 and the Russell 2000 all broke
uptrend channels signaling 1) a further consolidation or 2) a
larger correction lie ahead.   Wednesday’s weak bounce does not bode
well since most indexes hardly even made it back to test their break down
pivots. Traders should remain cautious until the markets become more oversold
or until
the indexes can re-capture these broken levels. We’ll know by the
beginning of next week if this is just a “bear trap” caused by options expiration
but until then, I’m operating under the guideline that a weak August
often precedes an even weaker September.  

On Tuesday, the S&P 500 broke down from a triangle at 1226 and a sideways
consolidation at 1223. Yesterday, the index mounted a weak bounce
that did not close above recent support levels.  

 

Even more worrisome is that the S&P 500 Equal
Weighted Index
(
SPXEW |
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PowerRating) broke down from a strong up channel. I often use
the S&P Equal Weight rather than the S&P 500 to gauge the market’s health
because it more accurately reflects how the average stock is performing. 
That index looks like it wants to test the support range from which it broke out
in July.

The S&P 600
(
SML |
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PowerRating) also broke down from a rising channel and looks like it
needs to test the support levels between 330 and 337.  I now expect a quick
move to the downside, reminiscent of February since the Bollinger Bands remain
compressed while the index broke support.  The Russell 2000
(
RUT |
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PowerRating) 
(not shown) broke a similar rising channel and is currently sitting on the upper
end of the support range.

 

Last week, Gary Kaltbaum made a prescient call for continued weakness in the
RETAILERS because the stocks have now followed through
on last week’s initial drop.  

One retailer to put on your screen as a potential
short candidate is Dick’s Sporting Goods
(
DKS |
Quote |
Chart |
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PowerRating).  The company has been a darling specialty retailer
since it came public in 2002 at a spilt adjusted $6 per share.  On Tuesday, the company reduced its earnings guidance from $1.82-$1.87 to
$1.70-$1.75 because of problems with a recent acquisition.  While this in
itself is not a horrendous shortfall, the stock was priced for perfection and
therefore gapped down from the high to the low $30s.  

From a fundamental perspective, problems with a poor acquisition are hardly
ever just “one quarter events,” in my experience.  Management’s
time and attention are often diverted for several quarters as they go about
fixing the problems, leaving the rest of the business to run on
auto-pilot.  This distraction often leads to additional problems in future
quarters.     

From an investment perspective, the stock now finds itself in  “no-man’s land” – it cannot be
classified as a growth or a value stock. At $32, the stock is still trading at
over 18x revised 2005 earnings guidance, which is relatively expensive for a
retailer that only grew combined revenues at 4% and reported comparable store
sales of 0.5% this past quarter.   Institutional growth stock managers
could continue to sell the stock and value investors probably won’t find the
stock attractive until it trades below 15x earnings, or under $27.  

And from a technical perspective, the stock is now extremely oversold and
could bounce.  However, I expect any rallies in DKS will present a good opportunity to
go short for a trade. DKS is a weak stock in a weakening sector.  The weekly chart
shows the stock has fallen below the triangle consolidation from which it
broke out.  In addition, the first significant support doesn’t come into
play until the stock tests the $26 – $30 range. 

Thomas Neuhaus is a principle of Investment Management of
Virginia, a registered investment advisory firm for which he co-manages. Mr.
Neuhaus’ career has encompassed all aspects of the investment business from
investment banking to sell-side research to buy-side portfolio manager.

Prior to working on the buy-side, Neuhaus worked as the head of technology
equity research for BB&T Capital Markets, where he covered the business services
and business intelligence software sectors.

From 1994 to 1997, Neuhaus was an Investment Banker for a regional investment
bank, completing initial public offerings, mergers & acquisitions, and private
financing for Business services, Telecom, Internet and Software companies.

Tom graduated from the University of Virginia with a degree in Finance.