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Don't Get Eaten Alive During Earnings Season
2/11/2013 2:53:00 PM
By: Martin Tillier
If you have ever followed the markets, you have experienced it. That much anticipated earnings report is released, the EPS handily beats consensus estimates and .. the stock falls. To outsiders and newcomers this is a constant mystery and source of irritation but, as with all things, there is a reason; or rather, one of many reasons.
Sometimes, even while earnings beat the analysts' best educated guesses; there is a worrying drop in revenue. Any improvement in EPS is likely to be short lived if sales are falling. Steel company Nucor (NUE) who released two weeks ago is a good example.
Holders of the stock would, at first glance, have been relieved when the earnings report was released on Jan. 29th as, after a week of declines in the stock price, EPS beat expectations by a whopping 50%, at $0.45 versus $0.30. However, Nucor also reported a miss on the top line, with revenues of $4.45 Billion, versus consensus estimates of $4.55 Billion and GAAP reported sales down 7.8% from the previous year. In light of that it is no surprise that the stock continued to fall in the next few days. The slight recovery of the last few days looks to me like an opportunity to sell.
Often, however, the reason is not so obvious. For example, analysts' estimates often don't match market expectations; there is a so called "whisper number." This is not a new phenomenon, nor is it exclusive to the US stock market. In the Foreign Exchange market, where I worked for around 20 years, the equivalent to a company earnings reports is the release of economic statistics by national governments. Asking a trader about any upcoming figures would invariably elicit the same response, "Well, we're expecting x, but I've heard it is y." On reflection, this is obviously ridiculous. I mean, do you really believe that every release of economic data is leaked? Of course not, but that isn't the point. If traders in general believe the rumor, then that is the number that is priced into the market. Thus a number can be roughly in line with estimates but still cause a violent reaction in price, leaving the average investor baffled.
This can also happen just because, ultimately, market sentiment trumps everything. This is what I believe happened to Apple (AAPL) this quarter. Revenues missed slightly on lighter than expected iPhone 5 sales, but EPS beat expectations convincingly. Given that at least some revenue shortfall can be attributed to an inability to keep up with roaring demand, this should be, at worst, a neutral report. The stock lost 10% over the next day. The market was still compensating for the over exuberance which led to a $700 stock price, and any news was going to be bad news. It is hard to escape the belief that, over the medium to long term AAPL is a solid investment at these levels.
Sometimes market sentiment can make a stock a one way bet going into numbers. EnerNoc (ENOC), for example, will release earnings on Wednesday. I believe they may be in a bit of a win/win situation. If earnings for the last quarter disappoint, the market will look positively at the rash of new contracts for ENOC's energy demand response system, and dismiss last quarter as history. If they beat, it will be seen as a positive and the upward trend will accelerate.
Understanding that some immediate post-release moves are more about market dynamics than fundamentals can help those who actively manage their own investments avoid some mistakes. There is a tendency to believe that we should try and be among the first to react to any news, but in these days of High Frequency Trading that is impossible. Given that fact, and the knowledge that the initial move can be based on something other than the actual numbers, a period of sober reflection is preferable to a knee-jerk reaction. Remember, while it is true that the early bird catches the worm, it is also true that the early bird gets caught.
Martin Tillier has been dragged, kicking and screaming, into the 21st century and can now be followed on Twitter @MartinTillier.