Profit From These December Earnings Disasters

by Traders Reserve | December 2, 2012 9:00 am

Profit From These December Earnings Disasters

Third quarter earnings season is well under way and one thing is certain: Many companies are in dire straits.

For the most part the numbers have been at best poor. Some would say abysmal. Bottom line profits might be meeting expectation, but revenues are coming up short.

For a forward looking market nothing could be worse. If sales are less than expected, there is only one way to keep profits high – cut expenses or raise prices.

Neither of those options is healthy in the long term, unless you a monopoly that can name your own price without impacting demand. Nope, the decline in revenues is a warning sign that should be heeded by any investor or trader.

For Earnings Players the clues in the early part of earnings reporting season provide a clear path to companies seeing profit destruction. That profit destruction ultimately leads to valuation destruction.

For traders anticipating that destruction, the profit potential is very real and very significant. In the case of companies likely missing earnings or revenue estimates, the best way to exploit such an event is with put options.

Earnings Players, buy those options right before the company reports and then after the news is released and the market over-reacts as it usually does the trade is closed. Triple digit gains are not uncommon.

What is needed then is to identify the companies that are headed for disaster.

Here are 4 companies reporting results in December that are likely to be the biggest losers:

1) Discover Financial Services

Discover Financial Services (NYSE:DFS[1]) reports results for the quarter ending November, 2012 on December 10, 2012. Wall Street is calling for a profit of $1.10 in the quarter. 90 days ago the estimate was for Discover to make 99 cents per share. The company has met or exceeded estimates[2] in each of the last 4 quarters. Shares of Discover have gained 73% in the last 12 months of trading. Analysts expect profits to slip in fiscal year ending November 30, 2013. At current prices shares trade for 10 times 2013 fiscal year estimated earnings.

The credit card industry has recovered nicely since the start of the financial crisis. Shares of companies in the group have appreciated accordingly. The peak though is near. Analysts expect profits at Discover to slip in the next fiscal year. The music is likely to stop when the company reports December 10. If so the fall from the peak could be dramatic.

2) Pier One Imports

Eclectic home furnishing retailer Pier One (NYSE:PIR[3]) reports results for the quarter ending November 30, 2012 on December 10, 2012.  Wall Street expects the company to make 25 cents per share in the quarter. That estimate is a penny per share higher than 90 days ago. Shares of Pier One have gained 69% in the last year of trading. Analysts expect profits to grow by 18% from the current fiscal year ending February 28, 2012 to the next. At current prices shares trade for 18 times current fiscal year estimated earnings.

Home furnishing might be the place to be with the home building market taking off, but much of the good news is already priced into stocks including Pier One. Keep in mind that it was only a few short years ago that Pier One was on the brink of collapse trading at penny stock levels. It’s been a nice run, but a poor earnings report could reverse this one in a hurry.

3) Joy Global

Mining equipment maker Joy Global (NYSE:JOY[4]) reports results for the quarter ending October 31, 2012 on December 12, 2012. Wall Street expects the company to make $1.91 per share in the quarter. 90 days ago the estimate was for the company to make $2.02 per share. The company has missed the number in 3 of the last 4 quarters. Joy Global shares have lost nearly 30% in the last year of trading. Analysts expect profits to fall in the current fiscal year ending October 31, 2013. At current prices shares trade for 9 times current fiscal year estimated earnings.

I can tell you exactly what will happen when Joy Global reports results. They will miss current estimates, revenues will be less than expected and guidance will be reduced. Now, much of this is already priced in the stock, but look for investors to hammer the company on such an across the board disaster of a report. I’d play Joy Global with a put option before the news is released.

4) Nike

Shoe and apparel company Nike (NYSE:NKE[5]) reports results for the quarter ending November 30, 2012 on December 20, 2012. Wall Street expects the company to make 99 cents per share in the quarter. That estimate is 2 cents per share lower than 90 days prior. The company has beaten the estimate in 3 of the last 4 quarters. Shares of Nike are trading flat in the last year of trading. Analysts expect the company to grow profits by 11% in the current fiscal year ending May 31, 2013. At current prices shares trade for 18 times current fiscal year estimated earnings.

Nike is a great brand. They are a global company that is growing profits at a double digit clip. Next year though profits are only expected to grow by 11%. That just doesn’t cut it in my opinion considering shares trade for 18 times current fiscal year estimated earnings. Given that rival Under Armour (NYSE:UA[6]) recently offered a report that was pretty decent and shares still sunk[7] on the news, look for Nike to be a big bust when it comes time for it to report results. The valuation divergence to expected growth is simply too easy to exploit on the short side. Own a put on Nike before the report is released in December.

Endnotes:
  1. DFS: http://studio-5.financialcontent.com/investplace/quote?Symbol=DFS
  2. met or exceeded estimates: http://investorplace.com/2012/09/discover-financial-still-cruising-still-a-buy-dfs/
  3. PIR: http://studio-5.financialcontent.com/investplace/quote?Symbol=PIR
  4. JOY: http://studio-5.financialcontent.com/investplace/quote?Symbol=JOY
  5. NKE: http://studio-5.financialcontent.com/investplace/quote?Symbol=NKE
  6. UA: http://studio-5.financialcontent.com/investplace/quote?Symbol=UA
  7. pretty decent and shares still sunk: http://investorplace.com/2012/10/under-armour-absorbs-the-heat-of-expectations-cmg-ua-lulu/

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