Irrationality Sells at Deb Shops

The Market is not rational.

There, I said it. And now for the proof: On Wednesday, teen clothier Deb Shops (Nasdaq: DEBS  ) pre-announced (huh?) some pretty impressive earnings for its fiscal 2004, and especially for the fourth quarter of 2004.

For context, when Deb last spoke on the matter, it predicted fourth-quarter earnings of about $0.45 per share and annual earnings of about $0.75 per share. But on Wednesday, Deb said the numbers are going to look a lot more like $0.62 for Q4 and $0.92 for 2004, when it officially announces results on March 9.

When the company originally predicted about $0.75 for fiscal 2004 earnings back in Aug. 2003, it pretty well shocked the market. Up until that point, it had been pointing analysts more toward numbers in the $1.25-1.30 range.

Now, if the Market were rational, Deb's share price should more or less track its earnings reports. But -- surprise, surprise -- it did nothing of the sort, at least not according to any logic that I can see. A check of the Fool's Historical Quotes page for Deb's stock prices around the dates of the past few earnings announcements reveal that:

One year ago, when Deb reported fiscal 2003 EPS of $1.84, each share sold for about $19. Shortly thereafter, the company predicted that it would earn only $1.25 in fiscal 2004, and after a bit of a shake-up, the shares settled again at $19. Let me repeat that: earnings dropped by a third, but the share price did not change.

Fast-forward to Aug. 2003, when Deb warned that instead of the already-disappointing $1.25 results, it now expected to earn only $0.70 for fiscal 2004. Share price? Eighteen dollars. Fast-forward another six months, to last week, when it still expected to earn $0.70 in 2004, and was up 30% -- selling for $23 a share. And yesterday, when it increased guidance from $0.75 to $0.92, the shares reached a high of $26.50!

At the risk of belaboring the obvious, Deb now expects to earn half of what it did last year, but because this bad news is less miserable than the bad news reported six months ago... the shares now sell for 40% more.

Anyone out there want to explain to me how a rational market came up with these prices? I am all ears.

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Motley Fool contributor Rich Smith owns no shares in Deb Shops.