Keys to trading earnings: Best Buy

Be cautious owning Best Buy in advance of its earnings report on Tuesday

By Jamie Dlugosch Sep 9, 2011 5:40PM

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 Best Buy (BBY) reports earnings for the quarter ending August 31, 2011.

 

Current situation:

 

Best Buy has rebounded from a big earnings miss for the quarter ending November 30, 2010 with two straight quarters of exceeding estimates:

 

Earnings History

Aug 10

Nov 10

Feb 11

May 11

EPS Est

0.44

0.61

1.85

0.33

EPS Actual

0.60

0.54

1.98

0.35

Difference

0.16

-0.07

0.13

0.02

Surprise %

36.40%

-11.50%

7.00%

6.10%

 

 

Retail sales have been a mixed bag. In the big box electronics category competition from discount retailers has pressured Best Buy to change its focus. The company has done well with smart phone sales, but high ticket items like big screen televisions and other non-discretionary items have fared poorly in the current environment.

 

5 stocks to buy no matter the direction of the market

 

Management is responding to the threat by attempting to go small. The success of that strategy is still to be determined. The average Wall Street estimate for the current period is for the company to make 54 cents per share. That estimate has held steady over the last 90 days.

 

For the full year ending February 28, 2012 Best Buy is expected to make $3.48 per share. In the following year Wall Street is looking for tepid growth of 6% to $3.70 per share. With the low expectations and recent share price declines the stock trades for just 7 times current year estimated earnings.

 

Over the last year shares of Best Buy have lost nearly 30%:

 

Analysis:

 

In a booming economy Best Buy and its big box model was primed to dominate its category. The industry lost players like Circuit City cleared the way for Best Buy to maximize profits. High unemployment and tight consumer budgets have driven customers to deeper discount options for electronics and other household appliance items. Give management credit for reacting to the threat by attempting to go small. Wall Street has low expectations for the company and is skeptical. Shares trade for a low valuation, but to the extent Best Buy has difficulty growing the price is about right. I would be cautious with respect to owning Best Buy in advance of earnings. This one could go either way.

 

Earnings Beat Probability: Best Buy has a 50% chance of meeting or beating estimates. Guidance is likely to be lower given weak economic forecasts.

 

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% over 8 weeks of earnings trades. 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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