Anomalous Price Behavior Following Earnings Surprises
January 20, 2021 | 14738 Views
Amongst the various factors which play a significant role in driving the stock markets, the earnings season is often a very confusing one. This especially rings true during the current situation where markets are at an all-time high & various industry§ors are pushing record valuations.
The ultimate measuring stick seems to be the earnings and the stocks which deliver will no doubt flourish & witness cash inflows whereas the ones which fail to deliver will probably be punished, especially if they belong to an un-trending sector or the wrong industry.
While this remains the view for the overall market, the story for individual stocks differs based on the strength of their reports. After all, every market has some winners & some loserts.
However, the question remains that why do some stocks fall off a cliff despite reporting positive earnings surprise while others skyrocket? StockAxis tells you why and brings you two smart ways of making substantial profits this earnings season!
1) High expectations of the investors.
Investors & traders are constantly tracking stocks and anticipating the next driving move which can lead to a substantial price movement. The earnings of a company play a huge role in determining the quality of the fundamentals and in turn the price of the stock.
Earnings surprise is something that happens when actual earnings are reported to be higher than earnings estimates. However, these ‘estimates’ are published by various financial analysts and the investors can often develop a unique set of expectations which could differ from that of the analysts.
When there is too much optimism in the markets, the actual earnings need to be some rather impressive figures in order to appease the inflated expectations of the investors. If that does not happen, the stock in question falls despite the ‘supposed’ earnings beat as markets truly discount everything way ahead of the time.
2) Low-quality Earnings
The stocks prices flourish under sustainable earnings. Such an earning has to be revenue earnings which are derived from the top line of the balance sheet. High sales & revenue earnings indicate that the company is operating under a profitable business model with demand and has promising growth prospects.
However, a lot of the companies report high earnings due to excessive cost-cutting and various other accounting gimmicks. This is highly unsustainable. Once investors catch up to the fact that the company has failed to generate increased & sustainable revenue from its core business, the stock prices are likely to drop regardless of the high beat.
3) Negative Forward Guidance
Buying a stock means buying an ownership stake in the company. As a rule of thumb, the future earnings streams are of utmost importance to the owners as it plays a vital role in the valuations of the stock.
Simply put, when a company beats earnings for the quarter just reported but warns that the future quarters could witness lower earnings, then that stock is destined to fall.
Two smart ways of making substantial profits this earnings season:
Having understood how the earnings surprise works and why the stock prices can fall despite reporting high earnings, let us now focus on how you can profit from this earnings season. We bring you a good way & an even better way!
The good way:
One way to make profits is from the ‘Post Earnings Announcement Drift’. All you have to do is buy shares of any company which declared an earnings surprise and rose significantly the following day.
Studies have shown that such stocks usually outperform the market over the next 9 months. On the other hand, it is advisable to remove the stocks which missed the estimated earnings from your portfolio as they are likely to underperform the market for the next few quarters. The downside of this approach is that there are literally thousands of stocks to choose from every quarter which can turn out to be quite a tedious & overwhelming task.
The better way:
Invest in stocks where the ‘earning whispers’ tip you off that you are in for a big surprise! Buy such shares shortly before the announcement and enjoy quick gains of 10%, 15%, 20% when the earnings surprise is officially reported.
We know what you are thinking. How is this even possible? Well, StockAxis has made it possible!
We truly believe that price reflects everything, the official & the unofficial. Relative price strength (RS) comparison is our proprietary rating tool which rates stocks based on their price-performance and helps us filter out the right stocks at the right time for our client’s portfolio.
When something is structurally changing in the underlying company, it is always reflected in the price and its Relative Strength (RS). RS is a leading indicator of price moves going forward. It indicates positive developments in the company and the possibility of buying interest from institutions and other large investors.
When we spot such price movements, we conduct intense research to reveal whether the uptrend in the price can be sustained. If the stock meets all other parameters, we make our recommendations which you too can easily profit from.
It would be our pleasure to assist you with your investments & help you curate a portfolio which can achieve all your financial goals. We wish you great financial success!