Bed, Bath & Beyond — How to Play Wednesday’s Earnings Report

Bed, Bath & Beyond (NASDAQ:BBBY) reports earnings for the quarter ending Aug. 31, 2011, after the market closes Wednesday. Retail stocks have been slammed during the summer swoon, but Bed Bath & Beyond has bucked the trend. Since mid-July, shares of the company have actually gained 2%.

But it will take a strong earnings report for the stock to improve upon those gains this week.

On some levels, selling retail stocks across the board makes sense. If a double-dip recession materializes, consumers will bear the brunt of the pain. Spending likely will decrease, and profits in the space will decline.

Earnings results give market participants a better gauge of the current environment, including a clearer view of the short-term future. Stock values are meant to be a discounting of future cash flows. When there is a wide disparity between speculation and actual results, traders can exploit the difference for gains.

Operating performance for Bed, Bath & Beyond has been quite strong during the past year, with the company beating estimates in each of the past four quarters:

For the current period, the average Wall Street estimate is for the company to make 84 cents per share. That number is two cents higher than where the average estimate stood 90 days ago. For the full year ending Feb. 28, 2012, profits are expected to be $3.68 per share. In the following year, the number is $4.23 per share, or 15% higher.

At current prices, Bed, Bath & Beyond trades for 16 times earnings. In the middle of August, Wall Street firm Cowen upgraded the company to “outperform” from “neutral,” citing valuation, strong competitive position and growth potential.

During the past 12 months, BBBY shares have gained an impressive 42%:

In a market of uncertainty, proven winners are seeing share values increase after reporting strong earnings results. In the retail space, cosmetic and fragrance retailer Ulta (NASDAQ:ULTA) gained 15% in the day of trading after it reported earnings that beat estimates and included strong guidance.

Guidance has been of particular importance for companies reporting results recently. In the case of Bed, Bath & Beyond, recent earnings results would indicate another quarter of profits that will beat expectations. For the stock to rise of any significance, future guidance will need to be strong.

A closer look at recent share performance shows the company selling off in July. A strong August rally — thanks to the Wall Street upgrade — erased those losses.

Retail sales were strong in August for many retailers. That bodes well for Bed, Bath & Beyond. With the company trading at a level equal to its expected growth rate, there is room for this stock to continue what has been a strong run of late. When Ulta reported results, its shares trade for a hefty 34 times earnings — well above its expected profit growth rate of 25%.

I expect a strong report from Bed, Bath & Beyond on Wednesday. Shares could gain 3% to 5% or more as a result.

Other companies reporting results this week include: AutoZone (NYSE:AZO), General Mills (NYSE:GIS), FedEx (NYSE:FDX), CarMax (NYSE:KMX) and Carnival Corp. (NYSE:CCL).