Lessons from the Pros

But It Beat Earnings… Why Didn’t It Go Up?

We are in the midst of yet another wild earnings season. One of the core concepts we teach at Online Trading Academy is the preservation of capital and the proper assessment of risk for any trade. The purpose of this article is not to teach you how to trade before an earnings release, that is extremely risky and is akin to gambling. No, I am writing this article to explain some of the actions you see after the earnings are released and the reasons behind the moves. Should you attempt to trade the earnings, it is much wiser to do so after the release and during the open hours of the market.

Earnings announcements, as we know, are a company’s statement of how they performed over the last quarter. The number you typically see released is the Earnings Per Share or EPS. The EPS is simply the net income of the company, minus the dividends to be paid on preferred stock, divided by the number of outstanding shares. For example, Apple earned $1,665,000,000 in their fourth quarter. They do not have dividends to pay and if we divide the earnings by the outstanding shares of 900,678,000, we see that the EPS was $1.85.

Analysts attempt to predict the earnings that will be released by the company every quarter. This can be an extremely difficult task and analysts’ estimates are wrong 85% of the time. However, this estimate forms public opinion and will be a benchmark set for those shareholders and watchers of the stock. So there are three things to watch for when traders are looking at earnings.

The first is the number released by the company in relationship to the analysts’ expectations. Obviously, if a company releases earnings that exceed an estimate, investors perceive that as a good sign and will typically want to buy the stock, thus raising the price. If the estimate is higher than the actual earnings, then shareholders will worry about the company and sell their shares, thus driving prices down.

Figure 1

The second key to the puzzle is what the company itself has to say about those earnings. Notice in the above picture the icon with a telephone and "T" or "W" next to it. This is the company’s conference call (telephone or web conference) where the CEO is able to address the shareholders and also guide the analysts for future earnings. This has a major impact on price direction, as well. If you look at Total System (TSS) near the bottom of that earnings list, you will notice that they beat earnings by a penny per share. However, look to the far right and take note of the red "G." That icon tells us that in their conference call, the company guided lower for future earnings.

Figure 2

Looking closer at the earnings, the company realized they would not be able to attain the goal set previously of $1.21 EPS for the fiscal year 2010. Instead, they attempt to set more realistic expectations of $0.95 to $0.97. This can warn analysts and shareholders for future company activities. So how does this affect the stock’s price? Well, TSS beat earnings but with the lower guidance, shareholders became nervous and sold off the stock.

Figure 3

Lastly, is it possible for a company to beat earnings estimates, have guidance come within expectations, but still have the price sell off? Absolutely! The third thing we need to watch for is a little known number called the whisper number. Many people refer to the whisper number as the real earnings estimate. It is a consensus number reached by an informal survey of professionals in the marketplace. They are observers of the companies, but not official analysts. This is the true number that the earnings announcement must beat for the stock price to rise.

Figure 4

Look at SLM Corp., (SLM) they missed their analyst estimates of $0.44 per share, but the price rose! This is due to the fact that they met the whisper number of $0.41. Professionals gladly bought as nervous investors sold and they were rewarded as the selling pressure subsided and price appreciated. I find the whisper numbers for free on a website appropriately named, www.whispernumber.com.

Figure 5

Earnings season is a volatile time. Having a better understanding of the forces driving price after the releases will increase your chances for success should you choose to trade the announcements. As always, avoid risky trades or ones that are outside of your comfort zone and have a plan for the trades you do take.

Have a great day.

- Brandon Wendell bwendell@tradingacademy.com