There is a tremendous amount of noise in the market that can influence stock price. Ultimately, the value of a stock is based on the present value of future profits.

 

When a company reports earnings results, market participants receive a key piece of information that can be used to determine the price of a stock. For a brief moment in time after a company releases its operating performance, the market will adjust pricing based on how the numbers match up against current expectations.

In many cases stocks of companies reporting results will move significantly higher or lower.

 

Understanding how investors use earnings against Wall Street estimates creates a profitable trading opportunity. Using a few key variables combined with understanding how the market will react to new information can guide you how to trade a stock in advance of the news being reported.

 

Use the Earnings Predictor to help you identify winning trades. On Tuesday Pep Boys (PBY) reports earnings for the quarter ending July 31, 2011.

 

Current situation:

 

Pep Boys has shown mixed results having missed estimates in 2 of the last 4 quarters:

 

In the most recent quarter the company missed Wall Street estimates by 7 cents per share. The poor performance can be attributed to supply disruptions in Japan. Prior to that the company had beaten estimates by a wide margin. The current period ending July 31, 2011 is likely to see continued supply chain issues in addition to being impacted by a pause in economic activity. Wall Street estimates for the period are 5 cents per share lower than where they were 90 days ago.

 

3 stocks in the dumps poised to rally

 

In theory, auto parts stores like Pep Boys should do well during a challenging economic period. Consumers looking to save money are likely to invest more in fixing cars already owned instead of purchasing new vehicles. With this report we shall see if that theory holds water. The key to a successful trade will be future guidance.

 

For the current fiscal year ending July 31, 2011 the consensus estimate is for Pep Boys to make 74 cents per share. That number jumps 27% in the following year to 94 cents per share. At current prices below $10 per share Pep Boys trades for just 12.5 times current fiscal year estimates.

 

Over the last year shares of Pep Boys have lost 7%:

 

Analysis:

 

The double whammy of supply chain disruption and economic slowdown has resulted in shares of Pep Boys dropping significantly since the end of May. Shares are down a whopping 35%. While it is likely that supply chain issues have been resolved, weak economic growth may be a hindrance to future profit growth. At the moment Wall Street has reduced guidance to reflect supply chain issues. Selling in the stock has gone way beyond what Wall Street expects of the company. Given that profit growth is now 27% and shares trade for 12.5 times estimated earnings in the coming fiscal year, the coil is tight for Pep Boys to move significantly higher. All that is needed is a solid report and guidance. A slow economy really shouldn’t be a problem for Pep Boys and actually may help sales. I would expect a good report when the company reports results on Tuesday

Earnings Beat Probability: CPB has a 75% chance of meeting or beating estimates and raising guidance when it releases results on Tuesday.

 

The Earnings Predictor (long recommendations only) had 24 winning trades and only 14 losers during the last July/August earnings season. The total aggregate return for subscribers was 12%. That compares quite favorably to the 12% loss in the S&P 500 over the same period. To become a subscriber for the October season, drop me an e-mail at jdlugosch@gmail.com.

 

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