3 Earnings Trades for the Week

Trading this week's earningsMINNEAPOLIS (Stockpickr) -- The waves of the market are changing. Trends in place for several months are starting to crumble, making the market more difficult for traders to navigate.

Stocks escaped last week with fractional gains thanks to a late day Friday rally. Without that move, the market as measured by the S&P 500 would been down for the week. Instead, stocks managed to eek out a fractional gain.

This sort of sideways market is particularly dangerous for traders. Without a clear direction, it is easy to get whipsawed. For those venturing into the waters, I recommend a strict adherence to the rules for whatever strategy you may be following.

With respect to trading stocks in advance of earnings, that means keeping a finger on the trigger to close positions should you find yourself on the wrong side of a trade. For my approach, that includes using aftermarket trading to exit a position should that become necessary.

That was starkly apparent with last week's buy recommendation of McCormick & Schmick ( MSSR). The seafood restaurant released disappointing results, which sent shares south -- and that move only became more severe after the company conference call.

Related: Rocket Stocks for the Week

Immediately after the release traders could have exited the trade with a 3% to 5% loss. If you had waited until the open the day after, you would have seen your shares down 8% to 10%. These little discrepancies can make a big difference in your returns.

Another example was Warnaco ( WRC), another buy recommendation from last week. Again, the news was as expected. Results were good, but the company noted margin pressure for the future that negatively impacted share price. It took some time for the full impact of the news to hit the market. An immediate exit of the trade could have been implemented, keeping damages to a minimum.

I cannot overemphasize the importance of following these rules. You are either a trader or you are not. If you decide that you want to trade these stocks, make sure you are paying close attention when news is released, and do not fret the trading cost of using the aftermarket to exit a trade. You will be better off in the long run.

On the positive side, we did manage to make some money selling Costco ( COST). The stock was priced for perfection, and its earnings report did not deliver the goods. Shares were down 2% to 3% during the trading day after it released its report on Tuesday.

With a sideways market that may be tipping south, I am changing my own approach to determining future outcomes with respect to companies reporting earnings. Here are three trades for this week.

Boston Beer

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The idea that an upstart microbrewery could have mass success was a novel idea 25 years ago. Historically, the beer industry had evolved from a market of local market players to a small group of giant producers. Basic rules of supply, demand and pricing dictated such an outcome.

Now, more than 25 years later, the success of a regional player is no longer in question. Boston Beer ( SAM) has more than found its niche: It is a very real player in a fairly large market. On Tuesday, we find out how the company finished its fiscal year ended Dec. 31, 2010 when it reports earnings results for the fourth quarter.

As evidenced by its stock appreciation, the last year has been a winner for the maker of Samual Adams beer. Shares have nearly doubled in the last month and now stand ready to break through the $100 mark. That said, a more cautious view might be to say that the stock is a bit ahead of itself.

Analysts expect Boston Beer to report a profit of 90 cents per share for the fourth quarter. That number is significantly higher than the 63 cents per share forecast by analysts at the start of the quarter. Apparently the recession has resulted in more beer drinking across the country.

The big increase in expectations stems from the company's performance in the third quarter, when it blew by estimates by a wide margin. As with many companies at the beginning of a recovery, expectations for Boston Beer were too low.

That may or may not be the case today. From a valuation standpoint, Boston Beer stock is now fairly pricey. Shares trade for 27 times 2010 earnings estimates of $3.51 per share. That number is expected to grow by only 12% in 2011. On a forward basis, the stock trades for 24 times estimated earnings.

That is a bit pricey. Should the company miss estimates, look for shares to stumble after the report. Boston Beer is a stock to trade short in advance of the report. Even if the company beats estimates, the upside should be limited.

Carmike Cinemas

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Unlike the majority of the market, Carmike Cinemas ( CKEC) has really struggled over the last year. The operator of movie theaters has seen its shares fall from a peak of approximately $20 per share last spring to $5 per share at the summer lows. Although the stock recovered a bit in the year-end rally, shares have been drifting lower since the start of the year.

Traders can expect more losses when the company reports earnings on Tuesday. With movie theaters facing stiff competition from home or internet viewing of content, I expect the company to miss analyst estimates, followed by a plunge in share price.

The current estimate for the Carmike is to post a loss of 5 cents per share for the period ended Dec. 31. That would put the full-year loss at 78 cents per share. While analysts expect the company to rebound in 2011 with a profit of 35 cents per share, such a result is unlikely considering that only 90 days ago, analysts were forecasting a profit of 11 cents for the fourth quarter.

That slippage in expectations during a period of strength for the economy should be troubling for investors. Even if the company does manage to make a profit of 35 cents in 2011, shares are priced at 19 times that number today. In other words, there is limited upside and plenty of downside for this stock.

I would trade this one short in advance of earnings.

Smith & Wesson

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Over the last two years, there has been plenty of hyperbole around gun stocks. Worries about changes to gun rights have been said to create significant buying demand for weapons and ammunition. Unfortunately for owners of gunmaker Smith & Wesson ( SWHC), there has been no such boost for stock prices.

In fact, since the election of 2008, shares of Smith & Wesson have drifted lower and trade fairly steadily between $3.60 and $4 per share. With the stock at $3.88 today, will the release of earnings on Thursday break the negative spell on the stock?

I think traders have a chance to make some money buying the stock in advance of earnings. Analysts are expecting a breakeven quarter for the period ended Jan. 31, 2011, with no change in that sentiment over the last 60 days.

For the full year ending April 2011, Wall Street is looking for the company to make sixteen cents per share. That estimate jumps to 33 cents per share for 2012. Therein is the opportunity for traders.

With the stock stuck in a rut, a beat of estimates could be what is needed to break out of the current trading range. That is the outcome I expect with the current report. Over the last year, the company has beaten expectations in each of the last four quarters. That trend should continue with this report.

In January, applications for gun permits jumped in the wake of the Arizona shooting. In addition, the economy has been strong during the period. The risk for a negative report appears to be low.

Shares of Smith & Wesson trade for just 12 times 2012 estimates that are expected to be double the 2011 number. That is a very cheap valuation considering the growth potential in the near term. Any strength in the quarterly report should result in this stock jumping significantly.

Trade Smith & Wesson long in advance of the report.

To see these stocks in action, check out the 3 Earnings Trades portfolio.

-- Written by Jamie Dlugosch in Minneapolis.


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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 .

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