Trade Alert: Post-Earnings

Betting on a stock with solid fundamentals that got punished despite beating earnings estimates on both top and bottom lines last month.

The Risk Of Buying After A Post-Earnings Drop

Everyone likes a bargain, so it’s tempting to bet on a once high-flying stock when it drops post-earnings. We did that with two stocks in the first quarter, Snowflake (SNOW -0.86%↓) and Lululemon Athletica (LULU 2.16%↑). Both posted double beats (on earnings and revenues), and both tanked after earnings: LULU by 16%, and SNOW by about 18%.

Both of those options trades expired worthless in June, even though one of those stocks (LULU) posted another double beat that month. Why?

In hindsight, we made two mistakes there:

1. We placed our post-earnings trades immediately, without waiting for prices to consolidate. Though the stocks were down double-digits post earnings, they kept sliding. LULU is now down 36% from the day it posted its earnings in the 1st quarter, and SNOW is down about 46%.

2. We didn’t pay enough attention to valuation. Even after those steep drops, LULU today has an overall valuation rating of 3 (on a scale of 0 to 10) according to Chartmill, and SNOW has an overall valuation rating of 0 (Chartmill’s overall valuation rating takes into account price/earnings, forward P/E, and other valuation metrics).

What We’re Doing Differently Today

The stock we’re betting on today is another former high-flyer that plummeted post-earnings, dropping about 18% after beating on top and bottom lines in August. This time, though, we did a few things differently:

1. We didn’t bet on it right after earnings, which were last month. We waited for prices to consolidate a bit. We’re not getting in at the post-earnings bottom, but the stock is still down about 16% from where it was pre-earnings. And we know now that its post-earnings plunge wasn’t the start of an extended slide, as with LULU and SNOW.

2. We paid attention to valuation. This stock has an overall valuation rating of 7 now, according to Chartmill data. Its other fundamentals are strong too: a profitability rating of 8, a health rating of 9, a growth rating of 7 (all on a scale of 0-10), and a Piotroski F-Score of 9 (on a scale of 0-9).

3. We waited to get the options prices we wanted.

Our options trade today is a bet that this stock will erase its current 16% post-earnings drop after it releases earnings next quarter. That’s well within the range the options market is predicting for this stock. If we’re wrong, our maximum loss on this trade will be 100%, and if we’re right, our maximum gain will be over 200%.

Details below.

Our Post-Earnings Trade