by   |   January 20, 2015   |   on ,

Beaten-Down Stocks to Buy This Earnings Season

Last week Alcoa (NYSE: AA) kicked off earnings season with a solid beat of estimates, but shares sank on the news.

It was an unusual reaction during an unusual week when earnings took a back seat to other factors — mainly the crash in oil prices and Switzerland removing the cap from its currency valuation.

Not only that, but Alcoa shares had rallied sharply in advance of earnings, thus creating a buy-the-rumor-sell-the-news sort of event.

With many stocks in the same boat, then, it might be a difficult market for investors during the current earnings season.

If you are looking for winners, Zacks Investment Research suggests targeting stocks that have been beaten down but are still likely to beat earnings estimates.

The key to such a strategy relies on a company having a history of beating the number and beating it by a wide margin, especially recently.

Knowing that many publicly traded companies have become adept at playing the earnings game and beating estimates by the proverbial penny per share, Zacks keys on those stocks that can surprise the market with a more substantial beat.

In addition, Zacks suggests targeting companies that, though beaten down, are participants in sectors that have underlying strength.

The idea here is that a rising tide will lift all boats even if said boat is leaking water.

Unlike Alcoa, shares of Noranda Aluminum Holding (NYSE: NOR) have struggled in advance of the company’s earnings report. The stock is down over 20% in the last year compared to a gain of 25% for Alcoa.

During the last quarter, Noranda exceeded estimates by more than 30%, making this one an interesting trade before the company reports results on Feb. 17, 2015.

With analysts seeing profits returning in 2015, Noranda is just the sort of beaten-down stock Zack is suggesting during earnings season.

The caveat is that this low-priced stock in penny stock territory entails significant risk. Though the company beat estimates last time out, it missed the number the two times prior.

Still, the aluminum industry enjoyed rising profits, thus Noranda appears poised for an earnings beat when it does report results. Given Alcoa’s results, going long the stock in advance appears to be a wise trade.

One earnings trade recommendation by Zacks that I would stay away from would be in the oil sector.

Zacks likes Diamond Offshore Drilling (NYSE: DO) despite oil prices crumbling.

Diamond has a strong history of beating estimates, exceeding the number greatly in three of the last four quarters.

Certainly the stock has been beaten down, but will earnings be enough to reverse the tide?

I don’t think so.

Most on Wall Street expect crude prices to fall to $40 or lower. If so, shares of Diamond will continue to fall no matter what the company reports for earnings.

More troubling is that current expectations for the fourth quarter have been the same over the last 90 days, a period when oil prices fell substantially.

At this point, analyst estimates in the oil patch are merely guesses.

The suddenness of the drop in crude makes forecasting extremely difficult — thus the chances for an earnings miss by Diamond Offshore are the same or greater than the chances of an earnings beat.

In general I think Zacks is right to focus on beaten-down stocks in winning sectors this earnings season, but I would stay away from any oil recommendations, at the moment no matter how tempting.