Deere & Company (DE), the big farm equipment dealer, announces earnings before the open on Wednesday, May 15, 2013. The company has an amazingly consistent record of falling after announcing, regardless of whether it exceeds or falls below analyst estimates. Here are the results for the past four quarters, with the stock price change from the close on the day before the announcement until the closing price on Friday (when the weekly options expire):
Deere beat estimates twice and came up short twice, but in all four quarters, the stock traded lower after the announcement. Ironically, the quarter when it came up short by the greatest amount (8/15/12), the drop in stock price afterwards was half as great as the loss in the two quarters when it beat estimates.
If the tendency for the stock to fall after an earnings announcement continues (and there seems to be other good reasons why it might), anyone interested in owning shares in the company would be well advised to wait until after the announcement to make their purchase.
Over the last several months, I have been testing the proposition that the level of expectations prior to an earnings announcement is a better indicator of what the stock price will do than the actual earnings themselves. Many times, this has proved to be the case, and I have enjoyed some spectacular results.
This proposition has not always proved to be true, however. In my Seeking Alpha article published last week - How To Play The Green Mountain Coffee Roaster... I made the argument that earnings (for GMCR) would exceed expectations, but the stock would probably fall because expectations were very high (measured by whisper numbers being well above analyst projections and the stock running up strongly prior to the announcement).
While I was right on the money with my earnings projection, the company also announced a new five-year contract with Starbucks (SBUX) and the stock soared about 25%. Of course, there was no way to anticipate such a development. On the other hand, the option spread I suggested (using the extremely high pre-earnings option prices which existed) gained 20% after commissions in spite of my being wrong about the stock dropping in price.
As was the case with GMCR, there are strong indications in DE that expectations are unusually high coming into next week's announcement. The stock price has moved steadily higher recently, gaining 12% over the past three weeks and whisper numbers are $2.91, or 6.2% higher than analyst estimates of $2.74.
The company is selling at a reasonable 11 times earnings and is paying a dividend with a yield of 2.3%, both numbers essentially equal to Caterpillar (CAT). Two weeks ago, CAT came up three cents short of estimates and the stock rose 5.1%, but it is significant that coming into the announcement, the stock had fallen 12% over the prior month, and whisper numbers were below analyst estimates, two indications that expectations were exceptionally low, so a near earnings miss was taken by the market as an encouraging development. This price action gave further support to my belief that expectations are more important than the actual earnings themselves.
Three companies with related businesses to Deere - CAT, Titan Machinery (TITN), and CNH Global N.V. (CNH) all reported disappointing earnings this quarter, and both TITN and CNH fell over 5% after announcing. (Titan has a chain of construction and farm equipment stores selling machinery and tools mostly in the Midwest, and CNH, based in the Netherlands, manufactures and sells a line of agricultural and construction equipment and parts worldwide).
I suspect that there might be a positive correlation between the earnings results for CAT, TITN, and CNH (all disappointments) and what DE will announce. Given the high level of expectations for DE, in my opinion, there is a good chance that the stock will trade lower after the announcement (continuing its pattern for the past four quarters).
For people not content to wait until after the announcement to buy stock at a bargain, I am planning to make these option trades:
Buy To Open 10 DE June-13 95 puts (DE130622P95)
Sell To Open 10 DE May-13 92.5 puts (DE130518P92.5) for a debit of $2.35 (buying a diagonal)
Buy to Open 5 DE June-13 90 puts (DE130622P90)
Sell to Open 5 DE May-13 90 puts (DE130518P90) for a debit of $.90 (buying a calendar)
These positions will take less than $3000 to put on. The risk profile graph looks like this, assuming that implied volatility (IV) of the June puts will fall from the current level of 21 to 15 after the announcement, about where it was after the last earnings announcement:
The maximum gain comes if the stock holds steady or falls by about $3, and there should be a gain of some sort no matter how far the stock might fall. The big risk is on the upside where any gain over $2 will probably result in a loss for the week. I don't feel as strongly about these spreads as I did last week with the GMCR spread, but they look pretty good considering the past history for DE after earnings, the high level of expectations, and the recent results for similar or related companies for this current quarter.
Additional disclosure: I plan to buy the bearish option spreads on Deere as indicated in the article.