Guess what time of the year it is? If you guessed tax season, you’d certainly be right, but we referring to earnings season and as usual we will do our little review of playing the earnings game.
We tend to think that more people have been hurt during earnings season than at any other time of the year. Why? Well think about it, it makes sense. You see a stock moving higher and higher, you’re convinced because the analysts have told you that this company is the second best thing to sliced bread. They have raised their expectations several times, and so you go for it. You buy the stock, they announce earnings and “boom” the next morning you’re down 6 dollars a share, despite the fact that they beat the numbers. What’s up with that?
There are several mechanics at work during an earnings release. Naturally you have the raw numbers themselves, such as, did they actually beat the estimates? Sometimes it appears as they have, but how’d they do it? If they did it on falling revenues, then they accomplished the feat by cost cutting or playing the currency spreads. None of them are indicative of great growth. Then we have the issue of just how much did they beat the estimates by? Quite often beating by a penny is so much more a matter of creative accounting than a real estimate of business growth.
Then of course there is the all important “guidance”. Remember that when earnings are released, it’s already old news. They are reporting numbers for the quarter that has already past. No one cares about history in this business or they would know it repeats itself and stocks wouldn’t be this high as it is, but that’s another story. People want to know what the company is doing now and what they think they will do in the future. If the guidance is mush, soft, soggy, or a million other descriptive words, then you can bet that the stock is going to take a hit.
If you study enough charts of enough earnings seasons, you are going to see something quite startling. Although the averages can indeed move higher during earnings season, the chances of your individual stock selection moving higher is really pretty iffy. The fact is that the risk reward scenario to holding a stock over the reporting session is pretty horrid and frankly we advise against it. That always brings out the howls from the crowd that says “Yeah, well I sold XXX ahead of earnings and it gaped up 6 dollars!” That’s certainly true it happens to hundreds of companies.play to earn game