Betting on a stock that tanked after earnings: Trying to avoid repeating two big mistakes: Lululemon Athletica (NASDAQ:LULU), Snowflake (NYSE:SNOW)

The Risk of Buying After a Post-Earnings Dip

Everyone likes a bargain, so it’s tempting to bet on a once-high-flying stock when it drops after earnings. We did it with two stocks in the first quarter, Snowflake, Inc. SNOW and Lululemon Athletica, Inc. lulu. Both posted double beats (in earnings and revenue), and both plunged after earnings: LULU by 16% and SNOW by about 18%. We made bullish option bets on both that will expire after their earnings this quarter.

Both options trades will expire worthless this Friday, even though one of those stocks (LULU) recorded another double whammy this month. Because?

In retrospect, we made two mistakes:

• We placed our post-earnings trades immediately, without waiting for prices to consolidate. Although the stock fell by double digits after the earnings, it continued to fall. LULU is now down 36% from the day it released its Q1 earnings, and SNOW is down about 46%.
• We do not pay enough attention to the valuation. Even after those sharp declines, LULU today has an Overall Valuation Score of 3 (on a scale of 0 to 10) according to Chartmill, and SNOW has an Overall Valuation Score of 0 (Chartmill’s Overall Valuation Score takes into account the price/earnings, in the future). P/E and other valuation metrics).

What we are doing differently today

The stock we’re betting on today is another former blockbuster that tanked post-earnings, falling about 20% after beating earnings but slightly below revenue. This time, however, we did a few things differently:

• We didn’t bet on it right after earnings, which were last month. We hope that prices consolidate a little. We’re not hitting the post-earnings bottom, but shares are still down about 15% from pre-earnings. And we now know that its post-earnings decline was not the start of a prolonged decline, as was the case with LULU and SNOW.
• We pay attention to the evaluation. This stock had an Overall Valuation Score of 4 before earnings, according to Chartmill, and after that drop it has an Overall Valuation Score of 6. Its other fundamentals are strong, too: a Profitability Score of 8, a Health Score of 7, a growth score of 8 (all on a scale of 0 to 10), and a Piotroski F score of 9 (on a scale of 0 to 9).
• We hoped to get the option prices we wanted and placed a limit order that took over a week to complete.

Our options trade today is a bet that this stock will erase half of its current post-15% decline after it releases earnings next quarter. If we are wrong, our maximum loss on this trade will be 100%, and if we are right, our maximum profit will be approximately 200%.

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