Big Lots’ Big Earnings Surprise

The market can be a confounding place.

Stocks rise and fall for so many different reasons, it’s nearly impossible to predict exactly what will happen. Truly confounding is when a stock plummets on what would be interpreted by most to be good news. Case-in-point: Big Lots, Inc. (BIG).

Early yesterday, before the market opened, this well-known close-out retailer released earnings that easily beat Wall Street estimates that even included increases in forward guidance.

Time to cash-in that big ticket right? Maybe…not.

Behind Big Lot’s Big Day

Here, we have a company performing just as expected, given the dismal economic conditions (see also, “A Healthy Dose of Reality”). BIG specializes in buying inventory that other retailers simply cannot sell. They then discount the items and sell them to buyers who can’t get enough bargains–buyers struggling under the weight of job losses, income stagnation and price inflation BIG had a winning formula for success. Six months ago such a business model would have resulted in enthusiastic buying by investors. Indeed, that is what transpired with BIG.

In January of this year you could have… owned shares of BIG for under $15 per share. Six months later shares traded for more than $30 per share. This was an amazing action for a discount retailer considering that the rest of the stock market was simply going south. With its earnings release, we have confirmation that the BIG model is right on track.

The stock will certainly go higher from here, correct? Not so fast.

Initially investors reacted favorably to the news in pre-market trading. But by the time the regular stock market opened the mood turned sour. As I write this, shares are down some 6%.

So what gives? We can start with the fact that the market is a forward-looking device that anticipates moves in advance of results. Essentially, investors discount that future to determine a price today. In other words, the results for BIG today have already been priced into the market.

Like a fire needing more wood to continue to burn, investors require more information so they can continue to buy. That’s the case with BIG as the company surprised investors by raising the guidance. Clearly, something is amiss.

From my point of view, the market is anticipating a strong economic recovery in 2009 and 2010 and BIG’s favorable headwinds may slowly disappear as the need for discounts and the availability of inventory dwindle simultaneously. If so, BIG may have trouble delivering positive results going forward.

So why not take some money off the table with these results? Locking in gains at a time when most stocks have declined is a wise investment strategy. The results for BIG would need to surprise us all with a much bigger margin to justify holding the stock for the long-term. We didn’t see that and the market reacted accordingly. I would suggest you do the same.

This article was written by Jamie Dlugosch, Editor, InvestorPlace.com. For more actionable insights likes this, go to: www.InvestorPlace.com.