Key words in company reports, still effective indicators?

In his book The Naked Trader, how anyone can make money trading shares, Robbie Burns highlights the secret Naked Trader traffic light system using a tool available on the financial site ADVFN.  In brief what this does is to look for key words in company news, statements, reports, announcements, etc with the intention of looking for positives and negatives.  This can then be used to find companies to both go long when positive and short when it is negative.  NT has apparently used it over the years to great success and using such words when searching for trading and investing opportunities is a useful weapon for all investors and traders to take note of and make use of. 

However, over the last 3-4 years there is something that I've noticed about one of these key words that for the Naked Trader is a red flag and that is the increased use of the word "challenging" by companies.  NT uses a nice and simple way of highlighting key words in reports by using a colour coded system.  Under red we have words like challenging, difficult, poor, tough, etc, while at the positive end green is used to highlight words like exceeding expectations, profit up, excellent, etc.  It's a good system that can lead to excellent trading opportunities.  Still, what I've noticed is that in these more challenging times companies are often reporting that they are doing well, but increasingly using red flag negative words in their statements that confuse the issue.

A case in point is WM Morrison reporting this morning a slight fall in profits, nothing drastic, but they say;

Sir Ian Gibson, Non-Executive Chairman, said:

"With ongoing commodity inflation continuing to weigh on already fragile consumer confidence and market conditions becoming ever more challenging, we have had to work even harder for our customers during the first half. Against this backdrop, Morrisons has increased sales and underlying earnings and delivered good dividend growth."

Dalton Philips, Chief Executive, said:

"Although the sustained pressure on consumer spending was reflected in our like-for- like sales performance, we have made further good progress against our strategic objectives - the building blocks which are the foundations of the future success of our business.

By the end of the year our new Fresh Formats will be in over 100 stores and we are now ready to launch our convenience stores in London supported by our new distribution centre. We have also extended our food production capabilities and will launch wine as our first online category.

We expect to make further progress in the second half of the year."

Outlook

We expect the challenging economic environment and consumer pressures to continue through the second half of this year and into 2013 and we have developed our financial and operational plans accordingly. Notwithstanding these conditions, the Board believes the Group will meet its expectations for the year.

So, we have red flag words being used in what is actually a reasonable performance given those conditions. I posted the other day good results from Ashtead, who also reported that they faced "challenging" conditions in the UK.  This use of the word challenging and other negative words seem to be more common and are perhaps more in line with the general economic uncertainty and therefore need to be balanced against the good points in a report to get the complete picture.  After all, if a company uses such key negative words in economic good times it's an obvious red flag that it is struggling and either to be left alone or for those that are inclined, shorted when the opportunity presents itself.  It isn't so clear when the economic backdrop is challenging, in fact you could argue that any company producing good, solid, consistent results against such a backdrop, even if they use words like challenging in their reports, are the ones to look out for.

So far today WM Morrison is up, I assume because the market accepts the fact that things are not as bad as they could be for the company and the outlook going forward is perhaps better, or not as bad, for the mainly food retailers than first thought.  Like Sainsbury and Tesco, Morrison has under-performed the market recently and sentiment for the sector has been negative. It will be interesting to see if it stays that way.  

Source;

http://www.digitallook.com/news/rns/20343642-10248/MRW-Interim_Results_html