Lessons from the Pros


Are You Earning on Earnings Releases?

April 11th is the earnings release date for Alcoa, Inc. This is considered to be the official start of the earnings season. Regardless of the earnings impact on the markets, one of the core concepts we teach at Online Trading Academy is the preservation of capital and the proper assessment of risk for any trade. The purpose of this article is not to teach you how to trade before an earnings release, that is extremely risky.  Instead, the purpose of this article is to explain some of the actions you see after the earnings are released and the reasons behind the moves.  Should you attempt to trade the earnings, it is much wiser to do so after the release and during the open hours of the market.

Free Trading WorkshopEarnings announcements, as we know are a company’s statement of how they performed over the last quarter.  The number you typically see released is the Earnings Per Share or EPS.  The EPS is simply the net income of the company, minus any dividends to be paid on preferred stock, divided by the number of outstanding shares.  As an example, imagine a company earned $71,000,000 in the last 12 months after dividends.  If we divide the earnings by the outstanding shares of that company, which happens to be 1,067,000,000 shares, we can see that the EPS was $0.07.

Analysts attempt to predict the earnings that will be released by the company every quarter.  This can be an extremely difficult task and most analyst estimates are wrong 85% of the time.  However, these estimates form public opinion and will be a benchmark set for those shareholders and watchers of the stock.  So there are three things to watch for when traders are looking at earnings.

The first is the number released by the company in relationship to the analyst’s expectations.  Obviously, if a company releases earnings that exceed an estimate investors perceive that as a good sign and will typically want to buy the stock thus raising the price.  If the estimate is higher than the actual earnings, then shareholders will worry about the company and sell their shares thus driving prices down.

What is the whisper number and how important is it?

The second key to the puzzle is what the company itself has to say about those earnings. Notice in the above picture the icon with a telephone and “T” or “W” next to it. This is the company’s conference call (telephone or web conference) where the CEO is able to address the shareholders and also guide the analysts for future earnings. This has a major impact on price direction as well. If you look at Synnex (SNX) near the bottom of the following earnings list, you will notice that they met their earnings estimates. However, look to the far right and take note of the red “G.” That icon tells us that in their conference call the company guided lower for future earnings releases.

What impact do earnings analysts have on fluctuations in the market?

What happens when a company doesn't meet earnings expectations?

Looking closer at the earnings, the company realized that they would be making less earnings for the next quarter. So, they attempt to set more realistic expectations for the analysts going forward. This can warn shareholders as well for future company activities. So how does this affect the stock’s price? Well, SNX met earnings, but with the lower guidance shareholders became nervous and sold off the stock.

Chart showing trading activity after earnings release.

Lastly, is it possible for a company to meet or beat earnings estimates, have guidance come within expectations, but still have the price sell off? Absolutely! The third thing we need to watch for is a little known number called the whisper number. Many people refer to the whisper number as the real earnings estimate. It is a consensus number reached by an informal survey of professionals in the marketplace. They are observers of the companies but not official analysts. This is the true number that the earnings announcement must beat for the stock price to rise.

How is the whisper number calculated?

Look at Paychex, (PAYX) they met their analyst estimates of $0.50 per share but the price dropped! This is due to the fact that they missed the whisper number of $0.51. Professionals gladly sold as excited investors bought, and they were rewarded as the buying pressure subsided and price dropped. I find the whisper numbers for free on a website appropriately named, www.whispernumber.com.

Should you trade based on earnings releases?

Earnings release season is a volatile time.  Having a better understanding of the forces driving price after the releases will increase your chances for success should you choose to trade the announcements.  As always, avoid risky trades or ones that are outside of your comfort zone and have a plan for the trades you do take.

Brandon Wendell – bwendell@tradingacademy.com

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

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