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Does Altria's earnings report mean it's time to quit?

Posted
11/4/2013 12:33:00 AM
By: InvestorsObserver
Referenced Stocks:MO

Does Altria's earnings report mean it's time to quit?

Michael Fowlkes 11/04/2013

Typically when a company outpaces analyst estimates with its quarterly earnings, we see the stock move higher the following day, but that is not always the case. For instance, Altria ( MO ) reported upbeat earnings before the market opened on October 24, but the stock lost 1.9% that day.

Given the fact that the stock has moved higher in the week following its report, you might try to blame its earnings-day sell off on a weak overall market, but that was not the case. On the day the stock fell 1.9%, the Dow Jones gained 0.6%, so there had to be another reason that Wall Street initially took a bearish stance on the stock.

First, let's look at the numbers. The company reported adjusted earnings of 65 cents per share, up from 32 cents during the same period last year, topping analyst estimates by a penny. Revenues climbed 3.4% versus the same period last year.

Given its strong earnings and revenue numbers, plus a strong overall market, a lot of investors were left scratching their heads wondering why the stock was so weak following the announcement. The answer may be found in the company's forward guidance.

With Altria coming off such a strong quarter, you might assume that it would raise its full year guidance, but it did not.

Instead, the company reaffirmed its previous 2013 full year earnings per share guidance of a range between $2.36 and $2.41.

Luckily for investors in the stock, Wall Street quickly overlooked the forward guidance and focused on what actually took place during the quarter, which was by all accounts very positive. The stock reversed its losses, and has managed to gain 3.5% from its closing price the night before its earnings release.

The real question is what does this say about overall investor sentiment. In my opinion, it shows that investors are more worried about the overall economy than many of us want to believe. There appears to be a real concern over whether or not the market can continue trading near its all-time high, and as a result Wall Street sold off the stock due to its not raising its full year guidance.

With Altria initially selling off following its earnings report and since trading higher, it can be a bit confusing for investors that want to play the stock. The stock is currently trading at its 52-week high, and I believe that it will be tough for the stock to trade too much higher from its current level, but there is a chance that it could add a little more to its recent gains. Given this view, I would want to set up a bearish trade, but with protection in case the stock does continue moving higher.


Image courtesy of stockcharts.com

A nice hedged trade on the stock would be the March 40/42 bear call credit spread. In this trade you would sell the March 40 call while buying the same number of March 42 calls for a credit of 30 cents. This trade has a target return of 17.6%, which is 45.7% on an annualized basis (for comparison purposes only). With MO currently trading at $37.50, this trade has upside protection of 7.5%.