Earnings season is a particularly interesting time for Wall Street because of the volatility it brings. Even during a year as volatile as this one, earnings season will almost assuredly create even more volatility in the equities markets.
A lot of traders use earnings as a catalyst to make short-term day or swing trades. They’ll do so using the headline numbers (earnings per share and revenue), and whether they exceed or miss consensus estimates.
Usually, how an earnings report compares to the estimate is all that matters in the short term. But that’s not always the case.
Before trading a stock based on its earnings, take a look at what it’s done leading up to the report.
Oftentimes if a stock has run up heading into its report, investors will punish it regardless of what the numbers actually say. The thinking here is that the stock has already priced in whatever gains would have been made from a good earnings report. When this happens, a stock will have to really exceed expectations in order for the stock to move up.
Look at McKesson for example. The stock had been on a tear heading into its Q2 report on February 1 (at one point rising as much as 24 percent from its Q1 report). They followed that up with an EPS beat, sales beat, and raised guidance. How could it not go up after an earnings report like that?
Well, it’s a matter of sentiment. Investors clearly felt the stock was just too overdone. So even though the company reported a stellar Q2 and raised its guidance for the fiscal year, the stock has since fallen 17 percent.
The opposite is true if a stock has been beaten up heading into earnings. Sometimes when this happens, just meeting expectations is good enough for Wall Street to pump it up.
This can be seen in Dick’s. The company’s Q4 report included a 1 percent EPS beat, and 2 percent sales miss. There’s nothing terribly wrong with those numbers, but they aren’t anything to write home about either. And yet the stock jumped 10 percent in the succeeding three days because expectations in retail are so low.
Other times, whether a stock will react positively or negatively to an earnings report is simply a matter of timing. If a company produces an otherwise strong report but does so on a down day for the market, then there’s a decent chance the overall sentiment will overpower that one stock.
This happened recently in Nike. After the bell on March 22, the company reported a Q3 EPS beat of 28 percent and sales beat of 1.6 percent. Those are good numbers. But the following day the stock closed down 3 percent.
Why? Well, the Dow Jones, S&P 500, and Russell 2000 all close down on the 23rd. This negative sentiment was enough to overpower what was otherwise a good report.
All of this isn’t to say that stocks will always behave like this, but it’s something to think about the next time you jump to make a trade-off of an earnings report.
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