During Earnings Season, Market Psychology, Fundamentals Should Guide Your Strategy

 |  Includes: COLM, SNA
by: Wall Street Strategies

by Brian Sozzi

Oftentimes investors become disenchanted with getting into a particular stock pre-earnings. Who could blame them? Not only are individual investors trading against the high frequency crowd, but they are at a disadvantage arising from a faulty approach to analyzing a company (there is more to stock analysis then pulling up news headlines on Yahoo). Reading news is perhaps 5% of the exercise in helping to solve the investment puzzle of a company. The rest of that puzzle includes studying historical valuations of the stock, comparative valuation analysis to others in the sector of choice, and a deep dive into the inner workings of the company. No one said investing was easy! But, building an investment procedure, which is always critical (and something we teach subscribers here at Wall Street Strategies), becomes even more so when you are deciding to trade with the big boys in the weeks and days leading up to an earnings release.

Detailed below are pre-earnings notes I authored on two companies from my coverage universe, Columbia Sportswear (NASDAQ:COLM) and Snap-On (NYSE:SNA). Pay close attention to my tie-in of market psychology with the fundamentals underlying the company, and realize this is something you should be doing on a regular basis.

Company: Columbia Sportswear Co. (COLM)

* Sector: Footwear
* 52-week high: $61.22 (October 13, 2010)
* 52-week low: $37.02 (November 27, 2009)
* YTD Price Performance: +49%
* Competitors: Nike (NYSE:NKE), Timberland (NYSE:TBL), Deckers Outdoor (NASDAQ:DECK)
* Claim to fame: Television commercials featuring founder, brown shoes, boots that have heaters in them

Tough to Warm Up to Columbia Sportswear

Columbia Sportswear Co. (COLM) will announce its 3Q10 financial results after the close of trading on October 21. In front of the announcement, I reiterating my avoid recommendation on the stock. My new price target of $55.00 (down from $58.00) is derived from a 20.0x P/E multiple on my FY11 EPS expectation of $2.75, which I have sharpened from $2.81. Currently, the stock trades at a P/E multiple of 21.0x my revised FY11 EPS estimate, a rich premium relative to others in my apparel vendor coverage universe (14.5x average) and Columbia's five-year mean of 14.6x. Applying my FY11 sales estimate, Columbia shares trade on a P/S multiple of 1.3x, basically in line to the five-year mean. I think the relative and absolute valuation of Columbia shares has upped the potential for a "sell the news" event on October 21. Columbia should beat on consensus sales and earnings estimates amid the launch of its Omni-heat product line and continued inventory replenishment by wholesale customers in the U.S, which notched above plan sales in the quarter (with footwear being a particularly positive call out). International currency translation will likely serve to boost revenues as well.

That said, a "sell the news" occurrence exists here as Columbia has beaten by a lessening degree on sales and EPS in its latest reporting periods, and with Columbia having embarked on a major advertising campaign for Omni-Heat, anything shy of a material trouncing will be viewed unfavorably by the market. Moreover, I am beginning to question consensus modeling for Columbia to deliver industry leading EPS growth in FY11, and the sustainability of FY10 EPS growth as costs of doing business ratchet higher and inventory replenishment subsides.

Company: Snap-On. (SNA)

* Sector: Auto, industrial, and consumer tools
* 52-week high: $49.88 (April 26, 2010)
* 52-week low: $35.25 (October 28, 2009)
* YTD Price Performance: +15%
* Competitors: Stanley Black & Decker (NYSE:SWK), Danaher (NYSE:DHR), Deere (NYSE:DE)
* Claim to fame: maker of tools that all but build things without human interaction, leader in productivity driving tools for critical industries, about to cash in on robust automobile uptake in China

Story of Snap-On continues to Snap into Place

Snap-On Inc. (SNA) will announce its 3Q10 financial results on October 21 pre-market. It's my view that Snap-On will have logged much better than expected sales and earnings for the quarter, supported by (1) end market demand recoveries in the U.S. and in key international markets; (2) growing importance of emerging markets for Snap-On; (3) shift in U.S. dollar dynamics relative to previous quarters, and associated P&L benefit; and (4) increased sales volume leveraged to a lean organizational structure following years of restructuring. Two areas of focus within Snap-On's lines of business include operating margin rates for Commercial and Diagnostic, each of which had a cooling sequentially back in 2Q10. Color on inflationary commodity costs and the expected impact to Snap-On in 2011 will also be closely monitored.

All of that said, I think Snap-On shares remain too cheap to ignore. The story of the company is strong; 20% EPS growth in FY10 and FY11 is within reach through increased sales to emerging markets and industrial customers, and a continued focus by management on expense rationalization. Moreover, Snap-On's $200 million 6.25% note maturing in August 2011 is likely to be refinanced at a lower rate, freeing up some interest expense pressure that has arisen in recent quarters.

Snap-On shares are valued at a mere 12.4x my FY11 EPS estimate of $3.87, almost half the projected growth rate in earnings y/y. On a P/S basis, and using my FY11 estimate, the shares are valued in line with the five-year mean; however the stock trades at a 30% discount to the five-year mean P/E multiple. Again, for the earnings story I envision playing out, even when applying a reasonable 16.0x P/E multiple to my FY11 EPS estimate, yields at least a fair value price target of $62.00 (which is now my new price target).