An Earnings Beat Isn’t Enough To Boost This Stock
Earnings reports include more than just information about earnings. It’s the details that many traders react to. For example, information about sales, or an outlook for the upcoming quarter, can be more important than the reported earnings per share.
One example can be seen in shares of Acuity Brands (NYSE: AYI) which were trading lower after the provider of lighting and building-management systems exceeded estimates for fiscal third quarter earnings but missed the sales estimate.
The Street reported that the company reiterated its demand outlook for the rest of calendar 2019. As part of the outlook, though, the company said fourth-quarter sales might be down “modestly” and that some leading indicators of demand in its markets “have recently softened.”
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For the fiscal third quarter ended May 31, Acuity reported net income rose 21% to $88.4 million, or $2.22 a share, from $73 million, or $1.80, in the year-earlier period.
When the company backed out special items, adjusted share earnings were $2.53 a share vs. $2.37 a year earlier.
Analysts surveyed by FactSet were looking for GAAP per-share earnings of $2.14 a share and an adjusted $2.42.
Sales edged up 0.4% to $947.6 million. The FactSet survey produced a consensus estimate of $969.5 million.
“We remain cautiously optimistic about overall market conditions for the remainder of calendar year 2019 and do not believe that the demand outlook has meaningfully changed from our outlook provided last quarter,” Vernon J. Nagel, Acuity’s chairman, president and chief executive, said in a statement.
Nagel called the third-period report “solid,” given “what continues to be a challenging market environment, particularly with ongoing angst generated by trade policy issues.”
The third-quarter gross-profit margin narrowed 0.7 percentage point to 40.5% from 41.2% a year earlier. Acuity estimated that the fourth-quarter adjusted margin should exceed that of the year-earlier period.
The weak earnings report comes as the stock is mired in a down trend and is trading about 50% below highs seen in 2016. The impact of the news can be seen in the weekly chart below which also shows the persistent down trend in shares of AYI for more than 18 months.
A Trading Strategy To Benefit From Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.
Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Source: The Options Industry Council
While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.
You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.
Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
A Bear Call Spread in AYI
For AYI, we could sell a July 19 $130 call for about $3 and buy a July 19 $135 call for about $1.02. This trade generates a credit of $1.98, which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position results in immediate income of $198. The credit received when the trade is opened, $198 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $302. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($198).
This trade offers a potential return of about 65% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if AYI is below $130 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $302 for this trade in AYI.