By Jack N., Communications Analyst and Blog Contributor
In my department here at Scottrade we have a little stock-picking contest. We don’t really buy stocks. We use imaginary money with fake trading accounts, and the winner gets bragging rights for a quarter. It’s fun, and you don’t suffer the sort of gut-wrenching anxiety you get when a security that you thought would be a winner turns out to be a dog.
Still, now that we’re in the middle of the quarterly earnings reporting cycle, we’re all a bit anxious. For real investors and traders, it’s TUMS®-chewing time.
Before I go further and talk about earnings, I want to say that I am not recommending you buy or sell the stocks cited in this blog. I’m using them solely to illustrate how stocks can behave during earnings season.
You probably know that a huge industry of analysts and researchers provides quarterly estimates of earnings for a few thousand companies. Many companies help out by providing “guidance” or forecasts of their likely net income and other financial numbers.
Despite those efforts, it’s common to see earnings surprises that move stock prices. Let me give you three recent examples:
Google Inc. (GOOG) stock price fell 9 percent in minutes Thursday afternoon (and trading was halted for a time) after a premature release of its third quarter earnings showed that profits fell well below analysts’ consensus estimate.
Yum! Brands Inc. (YUM), the holding company for Pizza Hut®, Taco Bell® and KFC®, reported earnings that exceeded estimates, while also raising its profit expectations for the fiscal year. The stock price rose 8 percent on the day of the announcement, reflecting both the unexpected earnings and the improved earnings forecast.
Winnebago Industries Inc. (WGO) went the other way. The company reported earnings estimates that were nearly 18 percent below expectations. While the company provided improved guidance along with its earnings, the stock price fell nearly 3 percent on the day of the announcement.
But here’s the rub: Not all stocks behave the same way to earnings surprises. So whether you’re a trader or investor, here are few academic studies to keep in mind:
- A University of Michigan study found that growth stocks tend to move more swiftly downward to bad earnings reports than other types of stocks.
- Companies with exceptionally strong positive earnings surprises can see abnormally large stock price increases for years in some cases, according to a study from researchers at Stanford University, University of Michigan and University of Utah. The researchers say that companies with large earnings surprises tend to continue having large earnings surprises.
- Stock prices rise even faster when companies reported a positive earnings surprise in the immediate quarter following a positive revenue surprise, according to researchers from Emory and New York universities. The study concluded that markets tend to underreact to the initial revenue surprise, but then catch up when earnings are strong in the following quarter.
That’s a lot to digest for both traders and investors. But rather than reach for antacids during earnings season, you would be better off with a diet of company and market research. That way, you’ll be better prepared when the next earnings surprise comes around.
Are there companies in your portfolio that have already seen earnings surprises this quarter? Are you planning to make any changes in your trading techniques or your portfolio composition as a result?
Also of Interest:
Jack N. is a communications analyst in the public relations department at Scottrade. He works to demystify the markets and the economy for all types of investors and traders.
Articles, commentary, and opinions expressed on this site are those of the author and not necessarily those of Scottrade. Scottrade does not guarantee the accuracy of, or endorse, the views or opinions of the author.
The examples and/or strategies described in this blog are for informational purposes only and their use does not guarantee a profit. None of the information provided should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security. Investors should fully research any security before making an investment decision. Securities are subject to market fluctuation and may lose value.