Materials get a rocky start to earnings season

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Michael Fowlkes 01/13/2014

It is that time of year again; with earnings season under way. It is an exciting time for investors, as with each passing day more and more companies post results of their most recent quarter.

A good earnings report can send stocks soaring, while worse-than-expected results can lead to sharp declines in share value overnight.

In the past, there was a great amount of attention paid to reports from aluminum maker Alcoa ( AA ). Since aluminum is used in such a wide array of products, Alcoa was viewed as the best bellwether stock for the overall economy.

Weak aluminum prices in recent years rocked the entire aluminum industry, with Alcoa being no exception. Aluminum producers have tried their best to support prices through production cuts, and while there are signs that things are improving, the sector as a whole is still pretty weak. So much so that Alcoa was actually removed from the Dow Jones Industrial Average in 2013.

But that is not to say we should no longer pay attention to what Alcoa is telling us. Alcoa reported its fourth quarter results on January 10, posting earnings of $0.04 per share. Analysts had forecast Alcoa to earn $0.06 per share.

The stock was trading at its 52-week high the day prior to the earnings news, but dropped 5% on the day of the announcement.

Another basic materials company that has already posted its earnings is Monsanto ( MON ). Monsanto is in the agricultural materials business, and it reported its fiscal first quarter results on January 9, and actually surprised Wall Street with a better than expected report.

Going into the report, analysts had forecast earnings of $0.64 per share, but actual results were much better at $0.69. While the earnings numbers were upbeat, its forward guidance was below analyst expectations. The company stated that full year earnings would fall in a range between $5.00 and $5.20 a share, lower than the $5.25 analysts expected.

Due to the weaker than expected forecast, the stock hit selling pressure following the report.

What this is telling me, is that the current earnings season may not turn out too well for the overall materials sector. However, just because I see weakness, it does not mean that there is not a way to profit from the expected weakness.

Even in a down market, smart traders are able to turn a profit. I would not want to bet against any one particular stock, but I think a reasonable way to play expected weakness in the overall materials sector is with a bearish hedged trade on Materials Select Sector SPDR ( XLB ).


Chart courtesy of stockcharts.com

XLB is a great way to place the expected weakness in materials because it is so widely diversified that you will not get burned if a couple of the companies actually post much stronger than expected numbers. We can hedge the trade in such a way that even if we are wrong, and the materials sector does trend higher over the next few months, that our investment will be protected.

A nice bearish hedged trade on XLB would be the March 48/51 bear call credit spread. In this trade you would sell the March 48 call while buying the same number of March 51 calls for a credit of 20 cents This trade has a target return of 7.1%, which is 36.7% on an annualized basis (for comparison purposes only). With XLB currently trading at $45.57, the trade has 5.8% downside protection.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

Originally published on InvestorsObserver.com


This article appears in: Investing , Options

Referenced Stocks: AA , MON , XLB

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