I have no problem shining a spotlight on earnings trades that have gone wrong. It doesn’t happen often, but losers are inevitable. Even this earnings season where my winners are beating the losers 2 to 1, you are destined to miss the mark when trading corporate profit news. (See my recent article on the “Key to Trading Earnings”.)
One earnings trade that went wrong was Priceline.com Inc. (PCLN).
The on-line travel reservation company is up an impressive 9% on Friday after reporting strong earnings results. This performance in the midst of a market meltdown is particular stunning.
When I make recommendations to trade a stock in advance of earnings I do so mostly on the long side.
That said there is money to be made selling stocks short that I believe to be over-valued and likely to report weak results. Given the uncertainty in the market heading into the last week such an approach seemed to be the perfect way to go.
Airline stocks have been slammed this year and that was before the market collapsed this week. Higher oil prices are to blame. In response the industry is scrambling to raise ticket prices potentially impacting demand for seats.
In addition weak consumer spending and the possibility of a double dip recession increased the risk that the travel industry would stall. With Priceline reporting results after the close on Thursday the earnings trade thesis would be that the company would begin to show weakness or at a minimum signal that challenges would be ahead.
Shares of Priceline have been on a straight line up. That appreciation made the stock expensive in advance of earnings. One potential slip-up and a collapse in shareholder value would be the likely reaction. Such was the case for fellow travel business, TravelZoo Inc. (TZOO) Its shares collapsed some 30% after it reported disappointing results.
At the time I made the recommendation to sell Priceline the stock was up 35% for the year. Shares traded for 26 times current year estimates of earnings. The stock looked expensive even though analysts pegged earnings growth above 20%.
When I make a recommendation to trade earnings I do so with the expectation that a trade is placed in the last hours of trading before the report is released. In the case of Priceline that would be on Thursday before the market closed. This week was quite different given the capitulation whereby traders would have benefitted from placing this short trade earlier in the week.
Be that as it may, Priceline shares were still expansive at the $480 lows touched on Thursday. The recommendation was still valid despite the selling. More importantly the fear in the market made it likely that stocks would head south on Friday. Just prior to the close the entry point for a Priceline short would have been at $483.
The Exit and Outcome
Priceline reported earnings results after the market closed on Thursday. The company reported a profit in the second quarter of $5.49 per share. That beat estimates of $4.87 per share. Guidance for the current quarter was also stronger than expected. The company forecast profits for the third quarter well above expectations.
Shares of Priceline jumped immediately on the news in afterhours trading. The only risk to longs was an uncertain open on Friday. Those fears eased with a strong labor report. Despite the volatility in the market Priceline opened higher and stayed there. Shares closed at $527 and change up over 9%.
Thanks to the volatility earnings traders could have rode Priceline down from the open. After an hour of trading I would have recommended covering at $520. That makes the trade a loser of 7%. Clearly the market Priceline has more confidence in the economy than the market at the moment.
The trade of Priceline was a loser, but I’m not sure I would do anything differently. There are plenty of expensive stocks that have missed results and traded lower. Even companies with low valuations and strong results are losing value this week.
The rationale on Priceline was sound. The company is simply doing better than expected. I was wrong plain and simple. It happens.
Not every trade will work out. They all don’t have to work to be very successful trading earnings. What matters is being able to cut your losses when a trade doesn’t work. Earlier in the week one of my trade recommendations on the long side made 15% for my subscribers. Net/net to be finishing this week with a fractional loss as we did with my service this week is a big victory.