Question about Earnings (GES)

MSW Member Question:

Hi Chris,

My name is Joe and I am a member of MSW. I have a question that I really don't understand. I am currently holding Guess (GES) and today it has an earning CC saying earnings beat estimates by 0.08/share. However, the stock dropped 10% with 800% more volume than average. The same situation happens to LMS where it dropped 20% with great earnings. Is there something wrong with the report that I have to pay attention to? Thanks for the advice.
(Actual member’s name has been changed for privacy)

My answer:

Two things you need to understand:

1. Current stock prices reflect actual or anticipated news and earnings from the past six months so the great earnings release today was already priced into the stock.
2. Future expectations and earnings will be priced into the stock today after the release based on the projections. All future moves of this stock will be based on the expectations at the next earnings release (essentially, the stock price is foreshadowing the price six months from now).
   

In the case of your stock, Guess (GES), it crushed earnings:

Q4 EPS Increased 73% Versus Q4 Last Year, $0.57 Versus $0.33
2005 Net Earnings Doubled Over 2004, $58.8 Million Versus $29.6 Million

Fourth Quarter Highlights
- Net revenues increased 23.5% to $276.6 million
- Comparable store sales up 15.9%
- Gross margin increased 310 basis points to 42.6%
- Earnings from operations up $17.3 million to $43.4 million
- Net earnings increased 74% to $25.8 million

2005 Highlights
- Net revenues increased 28.4% to $936.1 million; comp store sales up 9.2%
- Gross margin increased 310 basis points to 40.7%
- Earnings from operations reached $101.8 million
- Net earnings doubled to $58.8 million

Sounds great, right? WRONG. These numbers have already been priced into the stock. The stock broke out about six months ago above $25 as shown on the chart above. That was the proper time to get into the stock as it was trading on future expectations. Stocks move ahead of the news and not on the announcement of the news unless it’s extremely positive or negative (or a complete surprise).

Thursday’s 13% drop represents future expectations of the company and not the earnings that were released yesterday (again- they have been priced into the stock over the past six months). Here is the culprit of the recent drop in price:

LOS ANGELES, Feb. 16 /PRNewswire-FirstCall
Guess? Inc. today reported record financial results for the fourth quarter and fiscal year ended December 31, 2005. Net revenue and net earnings for the quarter and the year were at their highest levels since the Company went public in 1996.

Guess Inc. shares declined Thursday after the jeans and fashion retailer warned of moderated first-quarter sales growth. Stock of the Los Angeles-based company fell $6.05, or 13 percent, to close at $40.15 in heavy trading on the New York Stock Exchange.

For the first quarter, Guess expects same-store sales, or sales at stores open a year or more, to rise 10 percent. The company expects overall sales to rise in the mid-teen percentage range, a slower rate of growth than in the last couple of quarters.

Wall Street had expected revenue of about $249.6 million, about 16 percent higher than revenue of $215.6 million in the prior first quarter.

On a conference call, Chief Operating Officer Carlos Alberini noted the snowstorms in the Northeast and the occurrence of Easter in April in 2006, rather than in March a year earlier, would hurt comparisons.

For the month of March, for example, Alberini expects same-store sales to be "nearly flat," according to a transcript provided by Thomson StreetEvents. For the second quarter, the company expects same-store sales growth of 10 percent.

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As you can see, the current price drop reflects future growth and expectations and they seem to be flat so investors grabbed their profits and ran. The stock did manage to close above the 50 day moving average and it will be interesting to see if it holds support above this line (it has since the breakout above $25). The minute investors heard that the stock will not meet analysts expectations, they sold and ignored the great news from last year because they know that those profits have already been made.

An old Wall Street saying goes like this:
“Trade the rumors and sell the news”

Six months ago, the rumor was that this company was going to beat earnings expectations so investors started to buy. Now the rumor states that they won’t beat expectations, so they sold the news!

Piranha