Earnings Reaction: 3 Stocks To Buy, 2 To Avoid

Includes: AVP, GT, MET, WTW, ZNGA
by: Investment Underground

By Larry Gellar

In this article I'll be taking a look at five stocks that just reported earnings and that I think are selling at a significant discount to fair value. To consider a stock a buy I want to see not just a compelling valuation but also an upside catalyst. While Zynga (NASDAQ:ZNGA) and Avon Products (NYSE:AVP) reported losses, MetLife (NYSE:MET), Weight Watchers (NYSE:WTW) and Goodyear (NYSE:GT) were able to turn a profit. In the following article, I will explore whether or not these earnings reports have created a buying opportunity for investors given their cheap valuations.

MetLife, Inc. is a provider of life insurance that earned $1.13 billion last quarter. That translated to adjusted earnings per share of $1.31, which beat analyst expectations, while revenue of $16.75 billion was a bit of a disappointment. Regardless, MetLife was able to make a turnaround in some crucial areas. Investment revenue grew significantly due to an improvement in derivate net gains, and a new hedging solution for variable annuities also helped. I expect MetLife to keep improving its investment revenue by finding new ways to take advantage of low interest rates. Furthermore, MetLife's acquisition of American Life Insurance from American International Group (NYSE:AIG) helped to increase premium and fee revenue, particularly in the foreign arena. With MetLife's businesses doing well, the company is now making an important push for the government to allow it to increase dividends. Here's how CEO Steven Kandarian explained the situation: "We've submitted what we're comfortable doing in terms of capital redeployment for 2012 to the Fed and, again, we can't pre-judge things, but we feel good." Because MetLife has downsized its banking operations, I suspect that the Federal Reserve will let up, especially considering MetLife's plea that increasing dividends will improve the country's employment situation. I believe this stock is on track to rise now. On a discounted cash flow basis using a 10% weighted average cost of capital assumption, I value shares at $48 each.

Zynga, Inc. is a developer of online games that reported a loss of $435 million last quarter. Most of that loss was due to expenses related to going public, however, and adjusted earnings per share of 5 cents were better than Wall Street expectations. Revenue of $311 million also beat Wall Street estimates, which were $302 million on average. Here's how CEO Mark Pincus explained the situation: "Zynga set new records in the year in terms of audience size, revenues and bookings. We saw great momentum in mobile and advertising and ended the year with a strong pipeline of new games." While that's certainly a ringing endorsement, I don't think Zynga is a wise pick for investors. The current stock price implies a valuation of $8.25 billion, but it seems unlikely that Zynga is truly worth that much. Although Zynga's current lineup of games is popular, other competitors in the gaming industry can easily step in and put out games that would take away market share. I'd like to see Zynga focus more on the mobile gaming industry before putting my hard-earned money into this stock. "Words With Friends" is a great title for smart phones, but otherwise the company is very reliant on Facebook (NASDAQ:FB). In my opinion, this stock should be avoided for now despite its undervaluation. It lacks a near-term catalyst. I value shares at $16 apiece on a discounted cash flow basis.

Avon Products Inc. reported a loss of $400,000 last quarter. Poor sales and higher costs were to blame, and the company seems to be struggling to find direction. Although Andrea Jung is currently the CEO and chairman, the company announced in December that Ms. Jung would be working as a chairman only once a new CEO could be found. With that in mind, Ms. Jung had this to say on the earnings report: "My main message is that the organization is not standing still during this transition period. Teams are moving forward and taking action where it makes full sense and thoughtfully tabling others where we should definitely wait." Adjusted earnings per share were actually positive 39 cents per share, although this was still far short of analyst expectations of 51 cents per share. Revenue was a bit closer to Wall Street estimates, though, only missing by $60 million. I think Avon makes sense for investors trying to snag a big dividend. The yield is currently 5.2%, and a look at the statement of cash flows suggests that this should keep up. For instance, operating cash inflow for 2011 was $655.8 million. That was enough to fund other activities like capital expenditures, although investors should note that it will be a very long time before this dividend is increased. With that said, I still rate Avon a buy at current price levels because of its steep undervaluation. On a discounted cash flow basis, I value shares at no less than $30 apiece.

Weight Watchers International, Inc. is a provider of diet plans that reported earnings of $63.7 million for the fourth quarter. That breaks down to 86 cents per share on revenue of $401.3 million, and both numbers were a bit short of analyst expectations. Regardless, Weight Watchers management appears confident, and it is implementing two deals that will buy back $1.5 billion of stock if all goes as planned. In my opinion, Weight Watchers is a reasonably solid investment. On a year-over-year basis, meeting fees were up 11% and Internet revenues were up 60%. These are some of the Weight Watchers' most important operating statistics, and the business is growing quickly. While in-meeting product sales were down 22%, I wouldn't worry too much about this statistic. Weight Watchers should be able to adjust its business model to get those sales back on track, and they're not nearly as important as the meeting revenue and Internet revenue, which would be harder to fix if there was a problem. Weight Watchers is also trying some interesting new approaches to gain clients. Indeed, it is now starting to target larger corporations, and American Express (NYSE:AXP), NBC Universal and the New York Stock Exchange are three important examples. In my opinion, these moves will help Weight Watchers gain market share, therefore, I consider this stock a buy right now. On a discounted cash flow basis using a 10% cost of equity, shares are fairly valued at no less than $90 each.

Goodyear Tire and Rubber Co. is a maker of rubber products that reported earnings of $18 million for the fourth quarter. Adjusted earnings per share were 3 cents, and revenue was $5.68 billion. Both of those numbers were lower than Wall Street expectations, and Goodyear is suffering from a number of issues right now. Tire unit volumes declined significantly in Latin America, and the flooding in Thailand also had a perverse effect on the company's operations. Meanwhile, industrial customers in markets like the U.S. are becoming more reluctant to replace their tires and other products. Not all the news was bad, however, because Goodyear was able to successfully raise prices on a number of its products. Here's how chairman and CEO Richard Kramer explained the situation: "Our price-mix strategy was critical to our ability to offset record high raw material costs and the success of that strategy continued through the end of the year." Goodyear suffered a pullback due to the poor earnings report, of course, but this isn't enough for me to justify buying the stock. The price at the time of this writing is above $13, and that's too expensive considering competition from Bridgestone (OTCPK:BRDCY) and Continental (OTCPK:CTTAY) will remain strong. I will avoid this stock for now despite its undervaluation. Shares are fairly valued at 18 apiece but they lack any near-term upside catalyst.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.