Keys to trading earnings : Express

Bears have crushed several retail stocks - here is a trading story of a diamond in the rough

By Jamie Dlugosch Aug 26, 2011 5:45PM

The market is clearly at a tipping point. With stocks in correction mode, investors are clearly concerned about a double dip recession.  Wall Street economists have been cutting estimates for GDP growth over the last two months.

 

At the same time Wall Street analysts, those responsible for making forecasts of corporate profits have not yet adjusted downward. That disconnect creates plenty of opportunity to trade companies that are releasing earnings results. The real numbers will be given greater weight than Wall Street expectations.

 

In the last two weeks I have noticed a change in tone from those companies releasing result. While most companies are still beating analyst estimates the number of misses is on the rise. More importantly guidance for the future is noticeably weaker. There are stocks Warren Buffett will buy and stocks Buffett would not touch.

 

Stocks releasing disappointing numbers are getting absolutely crushed. It is not uncommon to see a stock in this category shed 20% or more in value in the immediate aftermath of the news. It is treacherous going to be sure, but money can still be made trading stocks on the long side. The key is to find companies that trade for low valuations, are likely to beat earnings estimates and raise guidance.

 

It is a tough barometer for sure. At this time of earnings season, we are getting results from retailers. Specifically clothing retailers are releasing earnings en masse. Heading into this past week my target earnings trade was Express.

 

The Situation

 

If the economy does indeed slip into recession, retailing stocks are likely to fall in value. The landscape is littered with stocks that are priced for perfection. Broad based selling has taken away some of the froth, but short sellers have been aggressive in their bets against the group.

 

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Despite the negativity about the space Express was attractive given its prior history of beating Wall Street estimates. As of the close of trading last week shares of Express were 30% lower since July 22. That pessimism was pure speculation of a dramatic reduction in business activity that had not shown up in any operating results or forecasts for the company.

 

At the $16.75 price on the close last Friday shares of Express traded for just 11 times current year estimates. Wall Street was pegging growth from the current year to next at 17%. Considering the company had met or beaten estimates in the last four quarters, that price was too attractive to resist trading in advance of the earnings report set to be released on Wednesday after the market closed.

 

The Entry

 

Shares of Express moved higher with the rest of the market on Monday. On Tuesday we saw significant losses in stocks like American Eagle Outfitters and Pacific Sunwear. That kept gains to a minimum allowing us to execute the trade on Wednesday.

 

I instructed subscribers to my trading service to buy shares at $17.73 per share. For sure the stock had gained a dollar per share in value, but there were more gains to be had in my estimation considering where Express traded in July.

 

The Exit and Outcome

 

After the market closed on Wednesday, Express reported results that beat Wall Street estimates. More importantly the company increased its guidance for the current fiscal year. Shares traded up to $18.80 in the after-hours market, but on very thin volume.

 

I had my subscriber wait until the Thursday before exiting the trade. Indeed the stock opened higher on Wednesday, but the gains did not stick. Fellow clothing retailer, Guess reported results that had its shares falling. The grip of the bears in the sector was strong.

 

Shares of Express in the very early going approached the after-hours high. When shares began retreating, I instructed my trading service subscribers to sell shares and close the trade. The exit price was $18.25. Immediately after closing the position shares attempted another short lived rally. When that rally failed, sellers pounced.

 

By the end of the day Express the stock closed only slightly higher for the day. At one point the stock was below $17.50. $18.25 was not the peak, but it was still a winning trade of 3%.

 

The Takeaway

 

There is a sea change occurring with respect to earnings reports. The strength of gains is simply not sustainable when bears are on the prowl. Typically I like to let these winning trades gain strength throughout the day. In this environment I have a quicker trigger finger to lock in gains.

 

Any trade that is positive in this market is a winning trade. The sustainability of any earnings pop is now in question. In any other market environment, Express would have been up some 10% after releasing such strong news. That said we take what we can get and move on to the next trade.

 

I had 3 winning trades and no losers this week. That brings the tally this earnings season to a gain of 13%. That is significantly above the market loss of 12% in the same period.

 

If you are interested in trading earnings and would like more information on my service – 8-10 weeks of trading recommendations beginning at the start of each earnings season, shoot me an email at jdlugosch@gmail.com  for more details on cost.

 

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