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5 Stocks to Trade Ahead of Earnings

Jamie Dlugosch, Stockpickr|TheStreet Contributor
Wednesday, 5 Oct 2011 | 9:49 AM ET

Third-quarter earnings season begins in earnest when Alcoa reports results on Oct. 11. For those looking to get a head start on trading earnings, several big names report results this week, including Costco, Yum Brands, Marriot International and Constellation Brands.

Investors have endured the brunt of speculative selling over the last few months. With earnings, we can move beyond speculation and begin adjusting to actual facts. Sellers are betting on a recession, and they may be right.

New York Stock Exchange
Oliver Quillia for CNBC.com
New York Stock Exchange

Recent economic data would seem to suggest that recession is inevitable—as does as a recent report from the Economic Cycle Research Institute. In fact, the leading economic indicators that the institute follows are indicated that a recession may have already begun.

Despite that gloomy prediction, investors tried to move stocks higher last week. A sell-off on Friday erased gains, and the S&P 500 ended the week off 0.44 percent. Once again the action was entirely unpredictable making it difficult for investors and traders alike.

Those trading earnings had an easier time of it. Two of the trades mentioned here last week did quite well. The suggested short of Micron was a winner, with that stock down 14 percent after a very disappointing earnings report. Another winner was the long recommendation of Jabil Circuits; the semiconductor stock gained 10 percent after reporting strong earnings.

Where will the winners be this week? Here are five stocks to trade in advance of third-quarter earnings season.

Yum! Brands

The fast food industry has enjoyed the benefits of expansion overseas. Over the last five years, stocks in the category, including Yum! Brands, have enjoyed significant gains thanks to foreign sales growth.

With speculation of a global slowdown, the run may be coming to an end. Particularly worrisome is China's effort to purposely slow economic activity in order to prevent rampant inflation.

Yum! Brands has beaten average Wall Street profit estimates in three of the last four quarters, including a beat of 5 cents per share in the quarter ended June 30. Analysts were unmoved. Estimates for the current period are a penny per share lower than they were 90 days ago.

For the full year, Yum! is expected to make $2.85 per share, with that number growing 13 percent in the following year to $3.21 per share. At current prices, Yum! trades for 17 times current-year estimated earnings. With a premium valuation, Yum! will need to beat estimates by a wide margin without lowering expectations for the future.

I don't see that happening in an environment of slowing growth. Look for the premium valuation to evaporate after Yum! reports results for the quarter ended Sept. 30 on Tuesday after the market close.

Costco

In the middle of swirling economic winds, some companies are performing quite well. Despite a down market, those companies with strong results are being rewarded with lofty valuations. When earnings results confirm that strong performance, richly priced shares can gain additional value—as was the case when Nike released results recently.

Costco reports earnings results for the quarter ended Aug. 30 on Wednesday. During the period in question, the company saw same-store sales gains of 10 percent or more in each of the three months. Wall Street estimates for the quarter inched higher by only a penny per share over the last 90 days. Currently, the average Wall Street estimate is for Costco to make $1.10 per share in the quarter.

For the full fiscal year also ended on Aug. 30, the company is expected to make $3.32 per share. Analysts expect profits to increase by 16 percent in the next fiscal year to $3.84 per share. At current prices, shares of Costco trade for 21 times fiscal-year 2012 average Wall Street estimates.

Given the very strong same-store sales in the quarter, look for Costco to beat estimates by a wide margin. Its business of selling retail goods at discounted prices is perfect for economic conditions that exist today. A premium valuation will take some of the steam from a strong report, but shares should still pop 3 percent to 5 percent.

Helen of Troy

Selling in the market over the last few months has resulted in some perplexing valuation situations, which could be resolved by earnings results. The actual news of earnings helps the market settle on price-based on discounting of future cash flows. One stock with a questionable valuation is Helen of Troy, which reports results for the quarter ended Aug. 30 on Thursday before the market opens.

Since the company reported its prior-quarter results in early July, shares have lost 30 percent. Those losses make little sense considering the company beat average Wall Street estimates in the quarter by 2 cents per share. Analysts looking forward don't seem to agree with sellers in the market. For the quarter ended Aug. 30, estimates have been adjusted lower by just 3 cents per share over the last 90 days.

For the current fiscal year ending Feb. 28, 2012, the average Wall Street estimate for profits is $3.40 per share, or 2 cents per share lower than the estimate was 90 days ago. In the following year, profits are expected to grow by 11 percent to $3.77 per share. At current prices, Helen of Troy trades for just seven times current-year estimates.

Look for the company to beat slightly reduced expectations for the quarter. With the stock trading so cheaply, gains after the report could exceed 10 percent. I would trade long the stock before the report.

Robbins & Meyers

Robbins & Meyers is an industrial company that makes specialized machinery for the pharmaceutical, energy and chemical markets across the globe. It is the sort of company that would struggle if indeed we are in the midst of a global recession. No wonder the stock is down more than 30 percent since the beginning of July.

The expectation is that operating profits will be weak in coming quarters. On Friday, fellow industrial company Ingersoll-Rand lowered its forecast for the future, sending shares lower. On Thursday before the market opens, Robbins & Meyers reports earnings for the quarter ended Aug. 30.

The average Wall Street estimate for the quarter has not changed in the last three months. For the full year also ended Aug. 30, the company is expected to make $2.33 per share. That number is expected to grow by 30 percent in the next fiscal year.

With the stock trading for just 15 times current fiscal-year estimated earnings, Robbins & Meyers looks cheap—but can you trust the numbers from Wall Street? If Ingersoll-Rand is any indication, you cannot. I would look for a reduced forecast from the company when it reports results. The actual performance for the quarter is likely to matter little. I expect the stock to fall further from current levels.

Constellation Brands

Wine and beer company Constellation Brands reports earnings results for the quarter ended Aug. 31 on Thursday before the market opens. If there is one business that should be booming during these difficult times, you'd think it would be the alcohol industry. There certainly is no shortage of consumers wanting to drown their sorrows.

Shareholders of Constellation Brands might want to drown their sorrows too; the stock is down 21% since the beginning of July. That is not the sort of action you'd expect for what should be a defensive stock. Recession or not, wine and beer sales are likely to remain stable—we shall see just how stable when earnings are released.

Over the last four quarters, the company has exceeded the average Wall Street estimate for profits. For the Aug. 31 quarter, the average Wall Street estimate has increased by 4 cents per share over the last 90 days to 66 cents per share. For the full year ending Feb. 28, 2012, the company is expected to make $1.98 per share, with that number growing 9 percent to $2.15 per share in the following year.

At current prices, Constellation Brands trades for 9 times current fiscal-year estimated earnings. Given the company's operating performance previously it is likely to beat Wall Street estimates. Shares should improve accordingly with a strong report.

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