How Do I Play Earnings Season?

Why Earnings Season?

Why is there an earnings season? It’s because the Securities and Exchange Commission (SEC), which writes the rules for equities listed on U.S. stock exchanges, says so.

According to the SEC, every publicly traded company has to file a Form 10-Q (for quarterly) unaudited financial statement for each of the first three quarters of the company’s fiscal year. And at the end of the fiscal year, there must be a 10-K report, an official, audited disclosure of all significant financial information.

Just as a side note, there’s really no reason for a company to have its fiscal year conform to the calendar year. Many retailers have fiscal years that end in January, which gives them until February to clean up after the holiday season, get their inventory straight and do their books. In fact, companies’ fiscal years end in virtually every month. Maybe they get a discount on their auditing for avoiding the peak season?

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Big and medium-sized companies get 40 days from the end of the quarter to file. Small companies (market cap of $75 million or less) get 45 days. Annual reports are due within 60 days of year’s end from companies with a market cap of $700 million or more, 75 days for companies whose market caps are $75 million or more, but less than $700 million, and 90 days for small caps (less than $75 million).

Earnings Hits and Misses: So What?

Most of the evidence that equity investors use to decide on which stocks to buy is probabilistic. There are no guarantees. A company that has been growing revenues and earnings quarter after quarter may keep the string going … or may not. And a stock with a low P/E ratio and good growth prospects may be ready to start climbing … or not.

But earnings season, when investors compare companies’ results with the “consensus numbers” (an average of the estimates of all the analysts who are following that company), is generally pretty clear in its verdict. If a company is supposed to make a nickel per share but makes six cents, that’s a beat. Everyone’s happy. If revenue was supposed to top $200 million but the report says $199 million, that’s a miss. Nobody’s happy.

Hitting the consensus numbers generally supports a stock’s price. Exceeding the number often leads to a jump in price, including the “gap up” that investors love to see. A stock that pops higher on the day after earnings (especially if trading volume has also spiked higher) often gets a dose of momentum that will power it to further gains.

So, How Do I Play Earnings Season?

The way to play earnings season depends on whether or not you own the stock whose report is coming up.

If you own the stock, you have four choices:

1. You can just hold through the news and trust to luck. If the stock goes up, you’re a genius. But the converse is also true.

2. You can sell part of your position ahead of the report. If you have a profit, this will lock part of it in, while still giving you exposure to a possible advance.

3. You can set a loss limit on the stock, which may get you out of the position with less damage. The problem here is that a disappointing report, especially one that comes out after the market closes, can produce an opening price the next day that’s below your stop.

4. You can buy an option that will allow you to make money even if the stock tanks.

If you don’t own the stock, you have three choices:

1.You can buy the stock (or short it) ahead of the report. This is the least attractive option, as you have no real idea of how likely the report is to beat expectations. It’s a little like playing Red on a roulette table.

2. You can wait for the report and then jump in quickly if the stock gaps up on good volume. Our research shows that a stock that gaps up on volume usually gets a longer-lasting boost that will keep pushing it higher.

3. You can buy an option that will give you a profit if the stock reacts big either way.

My own preferred way to play earnings season is not to play it at all. I keep track of when reports are due from the companies whose stock I own and then pay close attention to the reaction to the news. By using my usual loss limits, I can limit my downside, although a big miss can still hit hard enough to leave a mark. But if you’re picking good stocks, your gains will outweigh your losses over time.

If you want to know when your companies are reporting, the most reliable guide is the Investor Relations area on the company’s website. You can also try websites like Yahoo Finance. Go to the specific page for your stock and look in the left-hand column for “Company Events.” Just remember that any date for an earnings release that isn’t accompanied by an official message from the company itself is likely just an estimate of the predicted week for the report.

Good luck with your holdings through the remainder of this earnings season!

If you’re not fully invested and are looking for additional stocks to add to your watch list, consider taking a look at Cabot Emerging Markets Investor which I manage. Our portfolio has strong emerging markets stocks that are on track to deliver solid gains in 2018.

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Timothy Lutts

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*This post has been updated from a previous version, published in 2017.

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