Take Advantage of Earnings Estimates
A friend asked me if it’s possible to double an investment in the stock market in a month. My response was yes. My rationale is that if you research a particular company and can be apart of the volatility around the time of earnings, then you you can experience some of these risky gains.
Imagine if every three months you had to report how much money you made, how wisely or unwisely you spent it, and how much of it you had left. After giving your report, the financial world would judge your performance. That scenario sounds intense but this is exactly what publicly traded companies must do each quarter when they release an earnings report. Earnings events can be important to investors for two reasons: 1) These events have a significant impact on price and can generate a lot of volatility. 2) They are a way for investors to understand a company’s financial condition, which is the backbone of a successful investment. Before I dig into those reasons, lets discuss what an Earnings Report really is.
Every quarter, companies are required to report their financial performance to the Securities Exchange Commission (SEC). A typical earnings report includes at least three main financial statements: Income Statement, Balance Sheet, and Cash Flow Statement. The report is usually followed by a press release and public conference call where the company’s management explains the results and takes questions of analysts and investors. While earnings reports include a lot of helpful information, investors generally focus on Earnings Per Share (EPS). Though no single number can tell the whole financial story of a company, EPS is considered one of the most important since it shows how profitable a company is. EPS is calculated by taking a company’s net income and dividing it by the number of outstanding stock shares. At an earnings event, the actual EPS for the last quarter or year is released and compared to the company’s expectations (also known as guidance for that same time period). The actual EPS is also compared to Wall Street’s analyst’s estimates which are published. Comparisons are where volatility come in. If the company’s actual EPS beats expectations, it suggests that the company is stronger than analysts thought. This can cause the stock price to rise. However, if earnings are below analysts expectations, this suggests the company might be weaker than analysts thought. This normally causes the price to fall, and this is why investors generally expect EPS to meet or exceed analysts’ expectations. When reported earnings are significantly higher or lower that expected, this is called an earnings surprise. The market tends to absorb this information quickly (like within minutes of the release of EPS). Depending on the degree that the estimates were missed or exceeded, the stock price can jump dramatically. If you own individual stock, you see the largest moves in price around the times of earnings releases. These particular big moves are why speculators often trade around earnings. In addition to potentially expanding volatility, earnings can provide insights into a company’s operations and values. During the earnings call, management typically explains why earnings met or didn’t meet expectations. This is a chance for investors to evaluate the health of the company and determine whether it’s a good investment. You don’t have to be an expert financial analyst to gain valuable perspective of an earnings event. A brokerage firm, a financial website, or the company’s investor relations tab of their website are all great resources to find valuable data online.
To address the original question, if you absorb information leading up to an earnings release of a particular company and invest your entire investment portfolio in this trend, you could experience some significant gains. However, I do not recommend this unless you are an experienced investor. If you invest in a company that experiences an earnings miss, you could lose a significant portion of your investable funds.