Following a successful Q1 earnings season it is now time to turn our attention to Q2; and try to identify value in stocks that could rise following earnings. As Q2 earnings season begins there are still a number of small and mid-cap stocks that are presenting value, as a result of the market's rally being led by large cap stocks. My goal is to find and capitalize on this value throughout the following 5-6 weeks as I try to repeat the success of Q1 by finding stocks that can return gains following earnings.
Earlier this year I wrote a series of articles that progressed over a period of five weeks as I purchased stocks prior to earnings. In week one I began with $20,000 and then divided the money into several stocks per week. The returned gains or loss was then carried over into the following week and used to trade earnings throughout the series. As a result I will be starting the Q2 series with $24,000, which reflect solid Q1 gains, despite a very rocky start in week one of Q1.
For those of you are unfamiliar with the series I urge you to watch this video that I recorded as a way to explain the overall strategy. If you are following this series as a carry over from Q1 then I also urge you to watch the video for points-to-remember, possible changes for Q2, my outlook, and other important notes that must be known before the season begins.
Since this is the first week of the series I am going to be trading with caution. If you remember, last quarter I invested way too much into Google (GOOG) on week one, and despite the other weekly picks being solid, I ended the week with a significant loss. As a result, I plan to be conservative in the first two weeks, play with a large bank, and take few risks. The goal of the first two weeks is to simply get a feel for the market and any trends that may exist throughout the remainder of the earnings season. If you watched the video you will know that I am not too confident about the market's potential in Q2, and are investing in companies that meet a number of criteria. With that being said, let's look at the first plays of the season.
On March 29 Research in Motion (RIMM) announced earnings that were disappointing at best. The company that once controlled the mobile space missed expectations, continued to reflect its declining margins, and announced that it is giving up on giving guidance. Yet the stock traded higher in the day that followed earnings. My theory is that the absolute worst possible expectations were already priced into its stock due to a one year loss of nearly 80%, and a price/sales of just 0.36 (which is unprecedented in this space). By all accounts RIMM should not have traded higher, but I think it shows a good example of how to play a stock once expectations are near the bottom.
In week one I am buying a stock that some may compare to RIMM (not operationally but through technicals) in Alcoa (AA). Alcoa is typically the first of the Dow Jones components to announce earnings and has been a stock with a very negative disposition as of late. The stock has declined 45% over the last year and over 70% during the last five years. Its expectations for this current quarter are particularly low with revenue expected to decline 3.5% and an EPS of ($0.04). Over the last three months the average EPS expectation has fallen from $0.14 to its current loss of $0.04. And Alcoa has given analysts all the right reasons to expect very little thanks to it missing expectations in three of its last four quarters. The company also announced that it is cutting production to temper an oversupply of alumina, which further adds to the evident problems of a decline in demand, volatile price of aluminum, and a rise in raw materials. With that being said, I am buying AA because I believe expectations are now so low that it can surprise the market. The stock has already traded lower by more than 5% over the last 3 days and I wouldn't be surprised to see it trade lower ahead of earnings. As a result I plan to buy just $2,000 worth of shares, because I am not necessarily confident, however I do believe it is very possible that AA trades like RIMM with expectations that continue to drop. I don't think it will take a lot to surprise the market and believe its downside is limited because of its valuation and recent loss.
Over the years I have had the pleasure of interviewing several CEO's of large companies. For the most part, it usually feels as though they are reading off a script. However, one CEO that I really appreciate and consider genuine is JPMorgan (JPM) CEO Jamie Dimon. When Dimon talks I always listen, and since he likes to talk, I listen quite often. Dimon's words are often analyzed for any indication of strength or weakness, as was the case following his annual letter to shareholders. In the letter Dimon discussed the strength of the bank despite a challenging economic climate, and reiterated that 2011 was a record year in terms of net income. The topic of mortgage related losses was a hot topic along with the issues of meeting new regulatory requirements that can be costly if not done right.
JP Morgan is perhaps the most financially secure institution of the large banks. Despite several analysts focusing on the negatives of his annual letter I saw several positives for the company's long and short-term future. For example, the fact that it is returning record income in this economic climate is very impressive. I am also impressed by its aggressive buyback strategy, which includes buying shares at every chance that its allowed. But most importantly, I am encouraged by its expansion and the opening of new offices while competitors such as Bank Of America (BAC) have famously downsized. I feel very comfortable in using JPM as a gauge of the banking industry, and look forward to it reporting earnings next Friday. The company has met or exceeded expectations for the last three years, and is one of the safest investments of the large banks. In Q1 the banking stocks were strong performers and I believe we will get a good idea of its strength by the performance of JPM. Therefore, I am buying $2,500 worth of shares, which is still a small amount, but like I said, I am only trying to get a feel for the performance of this industry during week one.
If JPM is one of the most solid and stable financial institutions then I think some would argue that Wells Fargo (WFC) is one of the most improved banks. The company posted a strong fourth quarter earlier this year, and analysts are expecting strong bottom line performance due to several improvements. An increase in commercial loans and a surge in mortgage creation are reasons why investors and analysts are optimistic that WFC could perform well after earnings. Therefore, I will play WFC the same as JPM and buy $2,500 worth of shares prior to earnings on Friday, in hopes that the banking industry's strength will continue.
Back in January I got burned when I put too much faith in the consistency of technology giant Google to beat earnings expectations. In January, the stock was about to break through its top level resistance but came crashing down when its results were less than optimistic. The company is expected to post an EPS of $9.64 when it announces earnings on Thursday. And if the stock's recent trend is any indication of investor expectations then it appears as though the market is looking for the company to surprise Wall Street. This report is very important for several reasons: It will help determine the future direction of Google and if results are strong it could result in GOOG surpassing $670 and breaking into a new range. As an investor I will be curious to see how much market share was taken from Android due to Apple's (AAPL) success and if the company is making a splash in the daily and local deals industry, since it was an area of large investments. Overall, I think its expectations are attainable, but I am not willing to invest too much into its success. Therefore, I am buying $3,000 worth of shares prior to earnings.
I believe there are numerous opportunities for gains throughout this Q2 earnings series. However, my outlook for the second quarter is a little shaky because of strong Q1 gains. As a result I will be playing this season more conservative at the start, and may incorporate a number of calls and puts over the next couple weeks. My goal to be conservative is evident by my week one play of only $10,000 from my bank of $24,000 that is set aside for playing earnings. As the weeks progress we will be able to determine which industries are performing the strongest, and make better decisions. But for now it's best to be safe and get a feel for how the market is reacting to quarterly results. The last thing you want is to place all your eggs in one basket and buy a large sum of shares in a company that disappoints; which is why I always try to remind people that this is a marathon not a race and should be judged over a period of several weeks.
Disclaimer: The information in this article is not intended to determine any investment decisions. All investment strategies should be discussed with a financial advisor to determine whether or not it fits tinto your individual goals. The information in this article should not be used to make any particular investments and is intended for educational purposes only be used for informational purposes. Any and all investment strategies should be discussed with your financial advisor
Disclosure: I am long AAPL.