Every three months a new earnings season shows up bring with it new set of worries for investors. What are the current expectations? What might happen my stock beats expectations? What if they do not?
Some investors follow the hope and pray method. Others try to ignore the news from their company's announcement. The investors who consistently beat the market take a proactive approach to deal with earnings season challenges.
One quarter does not make a trend. A company's earnings release is a snapshot of the financial results for the last three months. The market often overreacts to a company's earnings scaring many investors into selling unnecessarily. Look at the history of the company's earnings to see if this is an aberration in the company's financials. Does it fit with the long-term trend of revenues, earnings and cash flows?
Do some homework in advance of the earnings release identifying the key drivers of financial performance. That way when earnings are released, you will have an informed idea of how well the company is doing relative to these important factors of performance.
If your company is delivering quality earnings and it fails to meet unrealistic expectations, any pull back in the price maybe a buying opportunity.
Expectations set the bar. Everyone measures the release of earnings against what the market analysts expect and what management offered as guidance. If a company misses expectations by a penny or in some cases does not exceed expectations enough the price falls as traders sell on the news. Think about that for a minute. A miss like that is not a catastrophe. It is a minor setback. If the underlying fundamentals remain solid, the company will continue to do well. Any pull back is a buying opportunity.
Listen to what management says. Often during the quarterly earnings conference call, management is more candid on their comments. These conference calls offer a wealth of inside information intended for the investment analysts. Listening to the call and hearing the answers to the questions posed by the analysts may give you a better understanding of how management views the future. If you cannot listen to the call live, most companies provide a link to the call for 30 days.
If management is cautious about the future especially sales and profit margin, it is time to take a second look. On the other hand, if a company misses their guidance by a penny, and they have a rational reason, dumping the stock is foolish.
Do some more homework. The press release is a sales tool the company uses to put their best foot forward. Most of them tell you very little about the quarter other than what management wants you to hear.
Wait for the 10-Q or quarterly report that is or will be released soon after the earnings announcement. Companies send their 10-Q to the Securities and Exchange Commission (SEC) in a very structured format. It contains a lot of information that provides a better guide into the real results.
Be sure to check out the cash flow statement to assess how well the company is generating cash. This is normally the first place problems show up. In particular, look at the Free Cash Flow Yield and its trend over time. If you note a move down look deeper to uncover why.
The Bottom Line
Earnings season brings more volatility. Successful investors use earnings season to shop for bargains that the instant traders dump without understanding the company.
Do your homework before and after earnings release day. If you do you will be rewarded, as you will have a better understanding of the company that most investors. With that understanding, comes profit for your portfolio.
