Playing the Earnings Game

October 14, 2006

Earnings releases dramatically move stock prices. Trading strategies for profiting from these swings can result in huge returns.

Earnings season gets into full swing this week, providing investors with direction on whether to continue the current rally or take profits. Public companies are required to report quarterly profit figures every three months. Included are profit figures, comments about how the quarter went, and an outlook for future business. These reports tend to dramatically move stock prices up or down. Earnings are very important, and considered the fundamental impetus for determining the share price of stocks.

The majority of companies report their earnings after the closing bell on Wall Street (after 4:00 PM EST). Some companies also release their figures before the markets open, favoring Wall Street professionals over standard investors.

The main things traders look for are the earnings-per-share results and how it compares to the average consensus estimate on Wall Street. This estimate number can easily be obtained on a general investment website (see: Investor Resources) If the number exceeds expectations, the stock will likely shoot higher as investors cheer the fact that the company has performed well.

Despite high earnings-per-share figures, companies can still disappoint on other measures. The company’s sales and revenue numbers are considered very important in judging the performance of a company. The companys guidance for the next quarter is also an important measure that can affect the Wall Street reaction to the earnings report.

Buying shares of a company immediately before earnings blindly is very risky, and shouldn’t be done without researching the company thoroughly. Understanding how the company has done in the past with relation to estimates, and the health of the business is vital to trading on earnings.

You may notice that everyone seems to be getting iPod's and anticipate that Apple must have had a good quarter. Conversely, you may notice that another product doesn't seem to be selling well at all. Observations from personal experience are very helpful tools in playing the earnings game.

Another way to play the earnings game is to trade immediately after the results are announced. If a company reports exceptional earnings results, it will likely have momentum to maintain an upward trajectory. One way to jump in is to trade in after-hours trading, which takes place after the market closes at 4:00 PM EST until 8:00 PM EST. Companies can pop up 5-8% instantaneously following the release of earnings, consolidate for a bit, then continue higher. This type of trading can be very volatile as investors try to digest the information presented in the report..

The SEC will occasionally suspend trading of shares in after-hours if a company releases a particularly confusing report and allow investors to digest the information, then let the market find its equilibrium. This is a rare occurence and doesn't necessarily mean the report is negative.

Companies will also host a conference call shortly after the release, during which senior executives discuss the past quarter and speak with Wall Street analysts about various aspects of business.

Buying shares during after-hours even at the highest point of the late session can be useful, because the next morning the rest of Wall Street will get wind of the positive report, and many more buyers will jump in. The same strategy can be employed when you are stuck with a stock that has reported disappointing results. Promptly dumping a loser can save you from a 5-10% additional loss the next day, before more panicked selling occurs.

These strategies to play the earnings game are not foolproof and should only be employed by investors willing to take on the risk of losing as much as 20% of their investment in the blink of an eye. But if you can accept this risk and uncover companies that have done great over the past quarter, you can pull in hefty returns in a single day that most people dream of making in a year. The road to triple digit returns lies in the earnings game.

Use the Dhinesh Financial Earnings Calendar to see which companies are reporting earnings soon, and test your earnings predictions.