MINNEAPOLIS (Stockpickr) -- Traders rely on volatility in order to generate rapid-fire profits. Typically, some sort of macro or micro event is needed for investors to push a stock higher or lower in price in a short period of time. One such event that reliably generates volatility is earnings.
Rightly or wrongly, when a company releases earnings for a period, investors react to the news. In some cases, these reactions can be quite strong and drastic. Building up to the event creates all sorts of speculation as to the results.
Wall Street analysts fine tune their spreadsheets in hopes of predicting exactly what a company will make. Whispers leading up to the event add more color to the story. When the numbers finally come, the market is primed like a pump ready to explode.
Beating or missing the number is a part of the equation, but so too is the guidance for the future. There is simply a little bit of everything and a whole lot of something that gets investors' attention when companies report results.
It is a perfect environment for traders who can accurately predict behavior and use it to ride the waves.
In the coming week, there are several companies from the retail sector that are reporting results. Here is my take on a few of those stories:
The hip clothing store for the younger generation reports earnings for the quarter ending Oct. 31 today after the closing bell. The current estimate is for the company to make 42 cents per share. The company has beaten estimates in each of the last four quarters, with the largest beat coming in the January quarter, when Urban Outfitters beat by 5 cents.
The estimate for the current period has been dropping slightly over the last few months. Those lower estimates are a direct reflection of the sense that the economy is not growing as strongly as hoped. During that same time, shares of Urban Outfitters fell below $30.
In the last few weeks, the stock has recovered along with the rest of the market. The current sense is that retail sales are holding up better than expected. It is reasonable for investors to assume that the company will exceed expectations when results are released on Monday.
Will that be enough to push the stock higher?
For the stock to continue its ascent, earnings will have to exceed 42 cents by at least 3 cents, because the current valuation of 16 times forward earnings is a bit high. Stronger numbers reduce the premium on the valuation, allowing the stock to increase in value. That is the outcome I expect and would trade.
Keeping with the retail theme, Nordstrom releases its earnings after the close today. Department stores have been a mixed bag during this young economic recovery. Over the last year, the company has been inconsistent with its results compared with expectations.
For the current quarter, analysts expect Nordstrom to post a profit of 52 cents per share. As that estimate has increased over the last 90 days, shares of Nordstrom have been on a tear, gaining more than $12 since early September.
Fueling the gains are strong same-store sales. The supposedly weak economy has not negatively impacted Nordstrom. Have such strong results been reflected in the current stock price?
On a certain level, the stock is due for a pullback. After all, nothing goes up in a straight line forever. Then again, shares trade for a modest 13 times forward earnings -- earnings that are expected to grow at a clip of 14% in the next fiscal year.
>>Who Owns Nordstrom?:
Given the mixed history on operating results, I expect Nordstrom to meet or miss expectations. Such a result will pressure shares lower next week.
Central Garden & Pet
The strength of the economy is directly measured by the strength of the retail customer. We'll stay in the category by taking a closer look at Central Garden & Pet. The small niche seller of lawn, garden and pet products reports results for the period ending Sept. 30 this week.
Analysts expect the company to make a profit of 14 cents in the period, a significant drop from the June quarter income of 40 cents. As a smaller company, operating results have greater volatility, making it difficult for analysts to nail down estimates.
Central Garden has seen its share price move more than 10% higher in the last three months. I'm not sure the move is supported by the numbers. The company missed estimates by 4 cents in the last quarter.
As for valuation, shares of Central Garden trade for less than 10 times 2011 expected earnings of $1.09 per share. That valuation would make it tempting to want to buy the stock at current levels.
I see the stock as a bit of a value trap. Earnings results are too suspect to merit taking the risk today. Given the ramp up in price over the last three months, weak or simply meet-the-number earnings will likely pressure the stock lower.
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At the time of publication, author had no positions in stocks mentioned.
Jamie Dlugosch is a founder and contributor to MainStreet Investor and MainStreet Accredited Investor. Formerly, he was president and CEO of Al Frank Asset Management. He has contributed editorially to The Rational Investor, The Prudent Speculator, Penny Stock Winners and InvestorPlace Media.