With earnings season just beginning—Alcoa (AA) is the traditional first reporter—there will be plenty of both agony and ecstasy to go around. And that will make it even more important than usual to keep your emotional equilibrium.
I know that taking an earnings hit can be very painful. I’ve had personal holdings that dropped up to 25% after a disappointing earnings report. The stocks that have been the strongest (which means they had attracted the most hot money) usually drop farther and faster than more sedate issues. And I felt like an idiot for not taking profits the day before the earnings announcement.
So here are a few observations on earnings season to help you maintain an even keel as the news gaps stocks both up and down with no warning.
1. It’s Not the Number, It’s the Expected Number. If all companies had to do to stay in favor with investors was to keep growing revenue and earnings, quarterly reports would be a piece of cake. But investors pay close attention to the earnings estimates provided by analysts, who, in turn, get to set the bar where they think a company should perform. So a company can lose money and still “beat expectations” by losing less than analysts thought it would and investors will view that as a victory and bid the stock up. But even a 100% jump in earnings can kill a stock if analysts had predicted 101%.
2. Companies Make Predictions, Too. Even if a company comes up to the mark on revenue and earnings, it can get dinged because its projections for results in the next quarter (or year) are subpar. The result is often as bad as for an earnings miss.
3. Stormy Weather Is Expected. After the rosy Q2 results that put a booster seat under investors’ confidence, advance guidance for the Q3 season has been running about two-to-one to the downside. Among S&P 500 stocks, pre-announcements now total 77 on the negative side and 34 on the positive side.
4. Don’t Fight the Chart. A stock that disappoints on revenue or earnings or guidance or margins or anything and gaps down huge on above-average volume should probably be sold. Big damage that shows up in a growth stock’s chart can take a long time to heal. You may be able to pick up a few points by waiting for the bounce that sometimes follows a big down day, but statistically, you’re better off selling than waiting for the stock to get going again.
5. Catch a Rising Star. On the upside, a big gap up on volume typically gives a stock a head of steam that will continue to push the price higher. So don’t let a big gain in a stock that soars on good results keep you from jumping on the bandwagon. Stocks get good mileage out of good results.
6. Keep a Razor Edge on Your Sell Disciplines. I’ve said this before, but it’s too important not to repeat. When you buy a growth stock, you should calculate your 15% and 20% loss limits and write them down where you can see them. This will help you to keep your head when bad news hits. If a stock hands you a 20% loss from your buy price at the close of trading, kick it out!
Here’s to a great earnings season with positive surprises in each and every one of your holdings (and mine, too, as long as we’re ordering up good luck)! And as always, I will be rooting for the stocks in the portfolio of the Cabot China & Emerging Markets Report, most of which have scheduled their announcements for November, as is typical for smaller, emerging market stocks. I’ll tell all of my subscribers how to handle the ups and downs for each holding, and I’d be glad to tell you, too. A quick click right here will get you started on a guided tour of the hottest markets on earth.
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