When you hold through an earnings report you take the risk of a potential negative surprise. Analysts often punish companies that surprise them with lower-than-expected earnings by revising future earnings estimates -- and targets for share price -- downward. Investors, in turn tend to punish companies that suffer this cycle consistently under the so-called cockroach theory, which holds that, like the insects, if there are two around, there's very likely to be a third in the offing.
I focus on three key areas:
1. The actual reported earnings versus the consensus estimate
2. Company issued guidance (what the company is saying about future earnings)
3. Stock price reaction to reported earnings and company issued guidance
Generally, if a company misses estimates by a meaningful amount or if the company makes a negative statement about future earnings - known as an earnings warning - and the stock price reacts negatively, in most cases I simply sell the stock immediately and step aside.
Here's an example of the earnings game roller coaster: On June 30, 2009 Rosetta Stone (RST) issued upside guidance for FY09; EPS of $1.22-1.26, excluding non-recurring items, vs. $1.04 consensus.
Less than two-months later the company lowered 3Q09 EPS guidance; EPS of $0.25-$0.27 vs. $0.32 First Call consensus, and vs. prior guidance of $0.33-$0.35. They also lowered FY09 EPS guidance; $1.14-$1.18 vs. $1.14 First Call consensus, and vs. prior guidance of $1.22-$1.26.
The company said "Our revisions are primarily due to greater than expected operating expenses for the quarter ending September 30, 2009.“
How much faith should you place in a company's comments about its future earnings? That depends on its track record. One indication will be its record for springing earnings surprises on the market.
If a company pretty regularly surprises with better earnings than anticipated, there's less to be concerned about. But if it tends to always surprise on the downside, you may want to take whatever it says with a grain of salt until the company proves itself. Newer companies may not allow you the benefit of historic reporting analysis.
Holding through an earnings report is a risky game. The only way to fully mitigate this risk is to avoid holding through the report, or through a hedging strategy, like buying puts perhaps.
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Mark Minervini
Posts
Mark,
ReplyDeleteWhat resource do you use for your EPS and earning numbers? Is the web site "Yahoo finance estimates" a reliable source?
Thanks again for your input.
Nergo
Mark
ReplyDeleteAs usual, great stuff.
Would you be writing about different stages of earnings cycles such as neglect, positive surprise, surprise models, estimates revised up, EPS momentum etc? Not sure if I understand what are the characteristics of these and what is the best entry point during the cycle?
Thanks
Hi Mark,
ReplyDeleteI see what you are saying but you also miss the chance of a stock running much higher. Look at Bucy for example. If you would sold before earnings, you would have missed the big run it had. So, could an idea be to sell maybe half a position before earnings. I guess the other risk is that on bad earnings, a stock could gap down and blow right through a stop loss causing a bigger than expected loss. On the other hand, holding part of a position through earnings, there is also the potential for upside. If for example you sell before earnings, and then the stock happens to go higher, do you get back, or do you let the trade go?
Hi Mark!
ReplyDeleteI emailed you a question yesterday if you had a trading service utilizing the SEPA method. You said not at this time. In the mean time as await your services, who would you recommend as a reliable professional trading service? I retire in about four years, been involved in mutual funds but they are not tailored for maximum profits, and I want to be more involved ("hands-on") with my funds. Who would you recommend until your services come available?
Nergo
Hi Mark,
ReplyDeletecan you tell a bit on how u handle a trade if there is an unexpected event happened to it? e.g. you bought at 10, and placed a stop at 9.5. But the stock gapped down to 9 on some event(non-earnings). thx
Negro,
ReplyDeleteThere are a number of good sources for EPS figures and estimates on the web. Yahoo and Zacks are good places to start.
-Mark
jakem5150,
ReplyDeleteIf I sell before earnings, in order for me to get back in the stock it would have to meet my SEPA® entry criteria. To answer your question directly, no, I would not get back in just because the stock went higher.
-Mark
Nergo,
ReplyDeleteI'm not sure what e-mail you are referring to that was sent to me. I may be offering a Minervini Private Access trading service available to the individual investor sooner than later. You may want to e-mail us again and get on the waiting list at privateaccess@att.net
-Mark
Earnings Trader,
ReplyDeleteWhen my stop is hit I sell, plain and simple. Otherwise, there is no sense in having a stop in the first place.
-Mark
We all know that companies try to carefully manage the information they share about future earnings, so they could always beat the EPS consensus estimate by at least a cent.This is why most companies beat and beating by a cent is no news at all. On the other hand, missing on the expected EPS is considered a sign of negligence, incompetent management and/or serious deterioration in the industry - something that cannot be changed in one quarter.
ReplyDeleteIn your experience, how often have you seen 2 or more consecutive quarters of negative earnings surprise? I have noticed that most companies tend to preannounce if they expect to miss in an attempt to soften the volatility associated with investors' reaction on earnings report day.
ivanhoff,
ReplyDeleteYes, companies do try to "manage" earnings all the time. Sometimes a company will use a negative statement as a sort of loss leader by dropping and earnings "bomb" to temporarily lower the analysts’ estimate bar in order to be able to clear it in the future. However, as a general rule, I DO NOT like negative surprises. I will try to address this issue in upcoming blogs.
-Mark