4 Factors That Can Impact How A Stock Reacts To Earnings


By: Spencer Israel

We’re officially into the Q4 2019 earnings season. Over the next 4-6 weeks, the vast majority of publicly traded companies in the U.S. will disclose their financial results for the last quarter, creating headlines for the media, volatility for stocks, and opportunities for traders.

But trading stocks around the release of their earnings reports is not simply as easy as buying those that beat expectations and selling those that miss. There are other forces that can factor into whether a company that beats opens higher or whether one that misses opens lower.

The following things can all move a stock in spite of its earnings report.

1) What Did Their Peers Say?
This is generally true for companies in the same industry or sector. If the first few companies in an industry beat Wall Street’s earnings and revenue estimates, that will set the bar higher for the companies that have yet to report.

Likewise, if the first batch of companies fall short of expectations, that will set the bar lower. We see this happen a lot in retail companies, which tend to report their earnings after most other companies.

In other words, if (hypothetically) Walmart ($WMT), Nordstrom ($JWN), and TJX Companies ($TJX) all report dramatically better quarters than Wall Street was expecting, the market will expect to see big beats from other retailers such as Target ($TGT), Macy’s ($M), and Burlington ($BURL).

2) Market Sentiment
An excellent earnings report does not guarantee the market will react favorably to the stock. In fact, the overall market sentiment can overpower the sentiment from a company’s earnings.

For example, on Dec. 3, the S&P 500 opened down 0.9%. That same morning, Bank of Montreal ($BMO) reported earnings, beating Wall Street’s earnings and revenue estimates by 8% and 20% respectively. Normally, beats of that magnitude would result in BMO opening higher—but not that day. The broad-based weakness in the market caused BMO to open down 1% despite the fact that they had good news.

3) Check The Trend
If the market is not exceptionally stronger or weaker when a company reports earnings, the next clue to look for to glean how the market may react is the stock’s recent trend. Stocks in the midst of a huge uptrend will more than likely require large earnings beats to keep the momentum going. Similarly, stocks in the midst of a downtrend have a much lower bar to please Wall Street.

A good example of this is the recent earnings reports of Chipotle ($CMG).

On Oct. 22 after the market close, Chipotle reported earnings and revenue above Wall Street’s estimates and gave a bullish forecast for their same-store sales growth. And yet, the next day CMG opened down 2%. Why? The stock had been on a great run, trading just below its all-time high at the time of its earnings report. Expectations were simply too high, and the market used the report as an opportunity to take profits.

4) Guidance
Because stocks get their value from future profitability, forward-looking statements like guidance are more meaningful than backward-looking statements like earnings from the prior quarter.

Take a look at the reaction to L Brands($LB) Q3 earnings report on Nov. 20. The company reported earnings per share of $0.02, in-line with estimates, on revenue of $2.67 billion (short of the $2.69 billion estimate). Those numbers aren’t bad, but they aren’t great either.

But the stock closed the next day up 7%, and at one point was up as much as 12.8%. This is because of the guidance. In the prior day’s report, L Brands said their earnings per share guidance for Q4 is $2.00 and their earnings per share for the year would be $2.40. Both of those numbers were better than the estimates, and the market rewarded a stock that has otherwise been in a long-term downtrend.

The author is long Walmart, Nordstrom, Target, Macy’s and Chipotle in his 401(k).

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