Would you like to go just after the summer rally? This industry is struggling


While no one knows for sure if the June low marked a true bottom, the formation of a market bottom typically begins with accumulation in specific industry groups and sectors. These leaders typically start their rallies ahead of the major indices. On the other hand, if this is a bear market rally, companies that can’t get much moving during the rally will mature as short candidates.

When a stock doesn’t move much while the broader market is higher, it’s telling us, “I’m very weak.” These stocks are great short opportunities if we believe further weakness is imminent.

The industries with a significant number of stocks experiencing negative earnings estimates tend to offer the best earnings opportunities, and this approach brings us to the restaurant company, which has underperformed for the year.

The company that owns a stock can help us determine which industry groups are poised to underperform. How can we identify which industries are likely to underperform the market? Luckily for investors, our Zacks Industry Rank makes the process easy. Zacks ranks all stocks into one of approximately 250 industry groups based on each stock’s Zacks Rank. The average Zacks rank is calculated for each industry group on each trading day.

We took the Zacks Industry Rank to the test, comparing how the top half (industries with the best average Zacks Rank) and bottom half (industries with the worst average Zacks Rank) performed against the S&P 500. the top half beat the bottom half by a factor of more than 2 to 1. Targeting stocks in the bottom half of industry groups when stocks are falling can clearly help us take advantage of volatility rather than succumbing to bear markets.

Let’s look at a recent example. The Zacks Retail – Restaurants industry ranks in the bottom 27% of approximately 250 industries. Quantitative research studies have shown that about half of a stock’s future price gains can be attributed to its industry affiliation. Also note the unfavorable characteristics for this branch:

Image source: Zacks Investment Research

Let’s take a look at one underperforming restaurant company in this underperforming industry.

El Pollo Loco (LOC)

El Pollo Loco develops, franchises, licenses and operates approximately 480 quick service restaurants. El Pollo Loco, a Zacks stock ranked 4th (Sell), has lowered its future earnings guidance, as we can see below:

Zacks Investment Research
Image source: Zacks Investment Research

For the current quarter, analysts have lowered estimates for LOCO by 45.45% over the last 30 days. The Zacks consensus estimate for Q3 now stands at $0.12/share, which represents negative growth of -55.6% compared to the same quarter last year.

On top of that, the stock just couldn’t get much off the ground during the summer rally:

Zacks Investment Research
Image source: Zacks Investment Research

A rise in food and beverage costs and labor costs in restaurants continues to hurt the company. Higher repair and maintenance costs also increase the costs. We have also seen many companies in the broader retail space indicate that the outlook for consumer spending is weakening. Because LOCO is dependent on consumer spending, the company is very vulnerable to the inconsistent nature of discretionary spending.

If you are looking for a short candidate, the hospitality industry is a good place to start.

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El Pollo Loco Holdings, Inc. (LOCO): Free Stock Research Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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