Earnings Trades: Alcoa, Lennar, H.B. Fuller

MINNEAPOLIS (Stockpickr) -- The market opened 2011 with some trepidation. Investors returning en masse were cautious given the impressive gains in December. It wasn't clear if a correction was forthcoming, and most of the buying was limited to the largest names in the market.

Certain momentum stocks and commodity names tied to the inflation trade moved substantially lower during the first week of trading. Noticeably, gold fell hard thanks to a strengthening dollar.

It was a mixed bag for our earnings trades last week. On a positive note, Mosaic ( MOS) greatly exceeded expectations and the stock moved higher by a few percentage points. The gains were short-lived as the commodity trade collapsed. Mosaic finished the week flat.

Related: Rocket Stocks for the Week

Sonic ( SONC) reported earnings that beat estimates helped by a tax benefit of two pennies. The narrow beat of estimates resulted in shares jumping. Traders betting the other side were able to get out of the trade with minimal damage immediately after the market opened.

Shares of Family Dollar ( FDO) were crushed by nearly 10% as the discount retailer reported profits that missed expectations by three cents. More troubling for the company was a reduction in guidance for the future.

The move in Family Dollar demonstrates the challenges for momentum stocks. One earnings stumble and shares are likely to collapse. The miss in this previously hot stock was stunning to say the least and could portend the future for similar momentum names.

The market offered investors several clues last week. While momentum names and commodity stocks retreated larger company stocks performed very well. The S&P 500 was up more than 1% last week.

In contrast, the smaller-cap stocks traded flat. On the commodity front, gold and oil both traded lower. The selloff in gold was triggered by the strengthening in the U.S. dollar and economy.

Clearly there was a rash of profit-taking in the market last week. Looking forward, earnings season begins next week with Alcoa ( AA) releasing its fourth-quarter profit number. After that report, the flood gates open.

I expect strong profit numbers to provide enough fuel for stocks to resume their climb. Here are a few reports to trade.


Content on this page requires a newer version of Adobe Flash Player.

Get Adobe Flash player

We'll start with the bellwether Dow stock. The aluminum giant reports earnings after the bell on Monday. Aluminum sales are somewhat of a barometer for the health of the global economy. Shares of Alcoa have traded essentially flat over the last year.

Looking at the one-year chart for the stock, shares looked poised for future gains. After a collapse in the first half of 2010, a strong rally in the second half of the year created a reverse head-and-shoulders pattern that some believe to be a bullish signal for the stock.

Over the last three quarters, Alcoa has met or beaten Wall Street estimates. The estimate for the current quarter is for a profit of 19 cents a share -- 3 cents greater than the estimate was 90 days ago.

At its current price of about $16.50, Alcoa trades for 31 times the 2010 estimate of 53 cents a share. In 2011, analysts expect the company to make $1.13 a share. The company trades for only 14.5 times that number.

For the stock to rocket higher, earnings need to greatly exceed current estimates. Given the underestimation of the global economy, an earnings beat is not out of the question. That would be the outcome I would expect and trade.

Making big bets on Alcoa are Louis Moore Bacon at Moore Capital, whose position in the stock is new as of the most recent reporting period, and Jim Simons' Renaissance Technologies, which increased its position by 693%. Recently, Jim Cramer highlighted Alcoa as one of several stocks providing big value at current levels, and it was one of his favorite Dow stocks for 2011. Dan Dicker also likes the stock, naming it one of his top commodity stocks for the year.


Content on this page requires a newer version of Adobe Flash Player.

Get Adobe Flash player

Shares of homebuilder KB Home ( KBH) soared more than 6% higher on Friday thanks to an earnings report that beat expectations. Does the good news there portend great things for the entire sector?

We'll find out soon enough. On Monday after the close, Lennar ( LEN) reports its results for the period ending Nov. 30, 2010. Lennar shares were up approximately 1.5% on Friday after the KB Home news.

Analysts expect Lennar to post a profit of 2 cents per share, a number that has been consistent for the past 90 days. As the homebuilding sector rebounded over the last year, Lennar has beaten estimates handily over the last four quarters.

Over the last six months, investors have been bidding up shares of Lennar in the belief that the bottom was finally found in the housing market. We've heard that song and dance many times, but a true recovery in housing has yet to begin.

What troubles me in the housing market, aside from the obvious fragile economic conditions and still-too-high housing prices in many markets, relates to the valuation of the homebuilders. Traditionally, homebuilding stocks are cheap when shares trade for 80% of book value.

Today Lennar trades for nearly 1.5 times book value. In order to support such a price, the earnings number will have to be fairly impressive and beat expectations. Given fourth-quarter weakness in housing sales numbers and continued price drops in markets across the country, I would not bet on a big beat by Lennar.

The KB number may just be a head fake. Traders can use the inflated prices for a nice short sale or put option purchase in advance of Lennar's number. A miss will surely send shares tumbling.

Lennar was one of Barclays' 30 best stock picks and Fortune's 10 best stocks for 2011.

H.B. Fuller

Content on this page requires a newer version of Adobe Flash Player.

Get Adobe Flash player

Traders get another read on the economy with the release of earnings by small-cap specialty chemical manufacturer HB Fuller ( FUL). A weaker dollar for much of the past year has helped foreign sales by domestic manufacturers such as Fuller.

Analysts expect Fuller to report a profit for the period ending Nov. 30, 2010 of 40 cents a share. That quarter marks the end of the company's fiscal year, and full-year estimates for the company are $1.55 a share. The company has beaten estimates in three of the last four4 quarters but missed by 6 cents a share in the most recently completed quarter.

Estimates 90 days ago were for Fuller to make 41 cents per share. I'm not worried about such a slight reduction given that the company missed estimates in the period ended August. Typically analysts reduce estimates after an earnings miss.

From a valuation standpoint, shares of Fuller are modestly priced. Shares trade for 13 times the 2010 estimate and 12 times the 2011 estimate. Wall Street has the company growing profits at a 9% clip.

What will propel shares higher are numbers that significantly beat estimates. I can see that happening on the revenue side, but I would be concerned about the bottom line. Higher commodity prices in the period may have negatively impacted profits.

A miss is the more likely scenario here. If so, shares will fall modestly.

Fuller is a U.S. Dividend Champion -- a stock that has raised its dividend each year for at least 25 consecutive years -- with a low payout ratio, which earned it a spot on Scott's Investments list of 10 Dividend Champions that can sustain their dividends.

To see these stocks in action, visit the Earnings Trades for the Week portfolio.

-- Written by Jamie Dlugosch in Minneapolis.


Follow Stockpickr on Twitter and become a fan on Facebook.

At the time of publication, author had no positions in stocks mentioned.

Dlugosch is the editor of Penny Stock Winners. He has over 20 years of experience in financial markets including investment banking, equity analysis and research and money management. In addition to being the Editor of Penny Stock Winners, he is also a Contributing Editor of InvestorPlace.com and founder and editor of The Rational Investor.

More from Investing

Dow Futures Tank as Trade War Fears Grip Wall Street

Dow Futures Tank as Trade War Fears Grip Wall Street

Why GE's Stock Has Fallen 9% in the Last 30 Days

Why GE's Stock Has Fallen 9% in the Last 30 Days

Billionaire Investor Tim Draper Explains Why Bitcoin Will Hit $250,000 in 2022

Billionaire Investor Tim Draper Explains Why Bitcoin Will Hit $250,000 in 2022

Worries About a Trade War Could Throw Wrench Into the Tech Stock Rally

Worries About a Trade War Could Throw Wrench Into the Tech Stock Rally

5 Stock Picks Under $10 for Millennials

5 Stock Picks Under $10 for Millennials