Pier 1 -- Let's clear up the misunderstanding

I got a question after my post this morning about the great earnings from Pier 1 Imports. Specifically, I was asked how I can like the company when the estimates for earnings for next year are one cent less than those estimated for the current year. This question illustrates a major misunderstanding about the stock that needs to be clarified.

The answer to this question is all about taxes. In the current year, Pier 1 is not booking any taxes as expenses other than various state corporate taxes. Because of the losses incurred during the recession, Pier 1 has a tax loss carry forward that it is using to offset any federal income taxes that would otherwise be due on its profits. The company has made clear that it has sufficient losses remaining so that it is unlikely to incur any tax expense for the quarter now underway as well. Starting with the new fiscal year on March 1, 2011, however, the company will have to begin to expense taxes since the loss carryforwards will be used up. The company says that it will be carrying taxes at 35% commencing at that time.

If one does the math, the current estimate of 70 cents per share for next fiscal year translate into earnings of $1.08 before the tax expense. using the proper pre-tax comparison, then the estimate for 2010 is 71 cents per share and the estimate for next year is $1.08 per share, an increase in earnings of over 50%. In short, the increase in earnings for PIR is great, but, after the tax adjustments, it looks like much less.

In many ways, these figures are much like the headlines about the earnings this morning. News organizations seemed almost uniformly to report that earnings had declined by a large percentage from last year for the quarter. Only a few of them, however, also reported that last year the earnings were entirely created by a one time tax benefit that the company got when it carried its losses back so as to earn a refund from the government. Again, this quarter was much better than last year, and the estimates for next year are much better than this year.

One last note: Since the earning for the quarter were substantially better than the Wall Street consensus, there will likely be increases to the estimates for future periods. I expect that the estimate for next year will climb by 10-15% over the next three weeks. As all of this information permeates the consciousness of investors, Pier 1 stock should rise nicely.