Stocks Worth Buying Before Earnings: Week 3

Includes: AMZN, CAT, NFLX, OUTR, S
by: Brian Nichols

It is safe to say that in week two of this quarter's earnings season nothing went according to plan. Both of the stocks I held following week one barely traded higher; I had bought Apple (NASDAQ:AAPL) at $600 believing it was a bargain for two weeks ahead of earnings, and all of my buys traded lower after earnings. I have been playing stocks before and after earnings for a long time, and last week was by far the most frustrating that I can remember. However, with several fast growing companies scheduled to report I will hope that week three mirrors the results of the first series, earlier this year, and not last week's results.

One of the reasons that last week was so frustrating is because the companies that I chose did not post horrible earnings. Select Comfort (SCSS) had strong earnings, Qualcomm (NASDAQ:QCOM) beat expectations but had soft guidance, Bank of America (NYSE:BAC) continued the hot streak for large banks, and Basic Energy Services (NYSE:BAS) was short on its bottom line but still posted revenue gains of 51%. In fact, there were several other companies who exceeded expectations and traded lower last week, and sometimes that's the way it works out.

I have stated on countless occasions that I am not too confident that this quarter will return the best gains. I believe the market is now appropriately price. I think the market is reacting too abruptly regardless of company earning results and that we are still facing economic hardships and continuously receiving negative headlines from Europe. In fact, I actually expect the market to trade lower in the coming months, and I think this upcoming week is critical with several fast growing powerhouse companies reporting earnings. But before we talk about week three, let's look at the results from last week, which are ugly at best.

Company Ticker $ Spent Buy Price Sell Price $ Returned Gain/Loss
Wells Fargo WFC 2,542 $33.00 $33.62 2,588 $46
JPMorgan JPM 2,467 $43.30 $43.60 2,485 $18
Select Comfort SCSS 2,003 $34.50 $33.50 1,943 ($60)
Qualcomm QCOM 2,956 $67.20 $63.30 2,785 ($171)
Basic Energy Services BAS 3,496 $15.20 $14.00 3,220 ($276)
Bank of America BAC 2,502 $8.78 $8.70 2,479 ($23)

After last week's performance I considered sitting the remainder of this quarter on the sidelines. Last quarter I had great results, but the market conditions have changed, and investors aren't reacting with the same level of optimism. However, in this upcoming week there are several great companies that are showing remarkable growth. I therefore feel it would be unwise not to take advantage of the possible returns. As a result, I am going to play another week of earnings, but with the understanding that the remainder of the season I will only buy stocks that I feel have enough "positive momentum" to trade higher. Because as we have seen in the first two weeks, it doesn't necessarily matter if earnings are good; it matters how the market reacts, and sometimes the market reacts without logic, which can provide good opportunities to buy stocks that inappropriately fall following earnings. Therefore, the best strategy during this quarter may not be to buy before earnings but rather after earnings. If a stock falls try to identify why it fell -- and if you can't identify any logical factors -- then it may have fallen as a market reaction and you may be able to buy it low and return a nice gain.

Last week I purchased 8 shares of Apple at $600 expecting the stock to rise before earnings. The company will announce earnings on Tuesday and is now priced at $573. I am really surprised at how Apple has performed over the last two weeks, but then again, I guess profit taking should be expected. It is amazing how quickly people forget just how many iPhones and iPads the company has sold, not including its other segments as well. The company is expected to post earnings of $9.99 which is nearly $4 less per share than last quarter, despite the iPhone sales still being strong and a launch of "The New iPad". Therefore, I can't imagine AAPL not posting a quarter similar to Q4, and beating expectations by another 30%.

Apple is the largest holding in my portfolio, thanks to a 44% gain since I bought it in December. And if we look back at the history of Apple, it does have a tendency to trade higher when it beats expectations. Therefore, I feel confident in my position and believe that it will trade significantly higher in the first three days of the upcoming week.

I recently sold and took profits from one of my long-term investments, Caterpillar (NYSE:CAT), after it surpassed $110 in February. The stock is trading near all-time highs but always trades with resistance near this level. However, the stock is one of the fastest growing large cap stocks in the market, and trades with very attractive metrics. It has a forward P/E ratio of just 9.50 and trades with a price/sales of 1.16, despite growing earnings by more than 50% year-over-year. Overall, I see limited downside, this is a company that is operating to perfection. Therefore, I am buying $3,500 worth of shares before it announces earnings on Wednesday and expect it to surpass expectations.

Netflix (NASDAQ:NFLX) has been a popular choice as some expect the company to exceed expectations and trade higher when it announces on Monday. In fact, I bought NFLX last quarter and it was one of my top performers due to low expectations. However, it appears as though the market is less concerned with current results and is only reacting to guidance. And I fear that NFLX is too unstable as a play this particular quarter. However, I wouldn't be surprised if the stock traded higher, but with this quarter being so unpredictable I am not willing to take the risk. Yet, I do think one of its competitors Coinstar (NASDAQ:CSTR) and its Redbox could outshine NFLX this quarter. The company's growing at a remarkable rate, has healthy metrics, and has become the most popular choice of movie rentals among consumers. Therefore, I am buying $3,000 worth of shares prior to it announcing earnings on Tuesday.

In my opinion, the iPhone is an absolute game changer for Sprint Nextel (NYSE:S). We have already seen an increase in revenue and subscribers due to the company now being able to compete with larger companies in the industry; because of it having the most sought after device and the only truly unlimited data plan. I hold a very large position in Sprint because I continue to accumulate shares when it trades lower, and believe that it is one of the most undervalued stocks in the market. Analysts are expecting a loss of $0.40 from Sprint, but the company has exceeded expectations the last two quarters due to cost cutting measures. I think we will now see a better bottom line as a result of the company already returning profits from customers who purchased the iphone during its first couple months. My only concern is that the company must continue to sell iPhones at a rapid rate, which I believe it will. Therefore, I am buying $3,500 worth of shares before its earnings to add to my already large position in Sprint.

You may notice that I am leaving about a $8,500 bank this week, rather than playing all of the money set aside for earning plays. My main reason for not playing more is because I am not confident in the performance of stocks following earnings during this particular quarter. I am confident in earning results, but not the reaction. And I also plan to buy more stocks following earnings throughout this quarter, however there aren't any from last week that I find appealing. Therefore I will play it conservative and be an opportunistic investor when value presents itself following earnings.

I will conclude with two stocks that I would avoid this week prior to earnings: Amazon (NASDAQ:AMZN) and United Parcel Service (NYSE:UPS). Amazon has become a popular choice among investors after eBay (NASDAQ:EBAY) beat expectations and traded higher. However, you must remember that EBAY has much better trading metrics with rising margins. Amazon trades with a P/E ratio of nearly 140 and is even expensive compared to total sales. It is inappropriately valued and does not have the momentum to carry it significantly higher if it slightly beats expectations, therefore I see too much risk. In the transportation sector I consider FedEx (NYSE:FDX) to be the best stock to own. Yet it missed expectations due to several reasons including increased prices for gasoline. The same problems that plagued FDX will most likely plague UPS, therefore I would consider cutting back shares if I owned the stock and buying back following earning results.

Disclosure: I am long S, AAPL.

Disclaimer: This material is for informational purposes only and should not be used to make any investment decisions until first consulting with a financial advisor. You may follow the author @bnichols9883 on twitter or @BrianNichols on stocktwits for trading updates related to earnings series.