Earnings season can be a very exciting time for traders and investors or it can make for the stuff of nightmares. Regardless of the earnings impact on the markets, the core concepts we teach at Online Trading Academy include 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. I am writing this article 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.
Earnings announcements 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. For example, if company XYZ earned $71,000,000 in the last 12 months after dividends, if we divide the earnings by the outstanding shares of 1,067,000,000 we see that the EPS for the company 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
The second piece 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 Taiwan Semi (TSM) near the bottom of that earnings list, you will notice that they beat earnings by eight cents per share. Additionally, if you look to the far right you will notice the green “G.” That icon tells us that in their conference call, the company guided higher for future earnings.
This is a good thing for the company and should cause investors to buy. However, there are many times when the guidance is lower. This can happen even when the company beat the earnings estimate. Looking at their next quarter or year, the company’s management is anticipating a slowdown in operations. The stock will usually sell off on this news even if the current earnings were good or better than expected.
Lastly, is it possible for a company to 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.
Look at Goldman Sachs, (GS) they beat their analyst consensus estimates of $4.32 per share but the stock gapped down and sold off after a feeble rise!
This is due to the fact that even though the company beat the street’s estimate they failed to beat the whisper number of $5.12. Professionals gladly sold as nervous investors bought on the earnings news 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.earningswhisper.com.
If you had waited for the earnings aftermath, you could have easily profited from a short at the supply zone with the professionals. Using other technical analysis tools would have provided you with the appropriate exits as well.
Earnings 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.