Best Way to Make Money on Earnings Surprises
Hold onto your seats for what promises to be a thrilling earnings season.
Stocks are walking the tightrope amidst several possibilities. Will parts of the country or the world experience a second wave of COVID-related shutdowns? Which party will win the upcoming elections in the US? Can the momentum in US stocks continue?
Yes, these challenges could create risks. But they could also create opportunities unlike anything we've seen since the depths of the Great Recession. Companies stuck remembering the glory days of yesteryear will see their stock prices plummet, while those which are best-positioned to profit from the new “stay home” economy will reap huge benefits.
When it comes to stocks, it’s all about the future. This brings to mind one of the most confusing things about earnings season:
Why do some stocks fall of a cliff on a positive earnings surprise while others skyrocket?
In this article we are going to tackle this little understood issue. Better yet, I will share with you two ways to profit from surprises this earnings season. More on that later.
3 Reasons Stocks Can Drop After a Positive Earnings Surprise
1) Estimates vs. Expectations: The standard definition of an earnings surprise is when actual earnings comes in higher than earnings estimates. But those estimates are the “published” numbers from the brokerage analysts. Quite often investors tend to develop their own unique set of expectations that can differ greatly from the Wall Street analysts. If there is too much optimism ahead of the release, then actual earnings will need to be a blowout in order to appease investors inflated expectations. This is the most common reason why some stocks fall after a “supposed” earnings beat.
2) Quality of Earnings: The highest quality earnings come from having robust revenue growth. This means that the company’s products or services are in high demand and should stay that way into the future. However, these days far too much of the earnings being reported is generated from cost cutting and other “accounting gimmickry”. The problem with that is that the benefits of these moves don’t last. When the market gets a whiff that the earnings are unsustainable, no matter how strong the beat, shares will most likely drop.
More . . .
Advance Notice of Positive Earnings Surprises
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3) Forward Guidance: Plain and simple, when you buy a stock you are taking an ownership stake. And what owners of companies care about is the stream of future earnings. So if a company beats earnings for the quarter just reported, but warns that future quarters will see lower earnings, then that stock will go down…and go down fast.
2 Ways to Make Money on Earnings Surprises
So now that we have outlined things that can go wrong after an earnings surprise, let's shift gears and talk about something even more important; How to turn a profit from earnings surprises. Here are two ways to go about it.
Good Way: Buy shares in any company that had an earnings surprise and rose the day following the news. These stocks experience what academics call the "Post Earnings Announcement Drift”. Studies clearly show that these stocks usually outperform the market over the next 9 months. Conversely, you should sell any stock in your portfolio that misses its earnings numbers as it likely to underperform the market for the next few quarters. The downside of this approach is that there are literally thousands of stocks to choose from every quarter.
Best Way: Find stocks where the earnings “whispers” tip you off that a big surprise is coming. Buy the shares shortly before the announcement and enjoy quick gains of 10%, 15%, 20% when the earnings surprise is officially reported.
I know what you’re thinking. There are no Magic 8-balls for the stock market, so how can this be possible???b But fret not; this isn’t a magic show. It’s pure science.
The concept of finding a profitable source of earnings whispers has long been the Holy Grail of stock investing. Many experts have tried and failed to make this work. In fact, we had been researching this for countless years.
Early on we found clues that told us which stocks are more likely to surprise, but not necessarily rise in price. It wasn’t until the summer of 2010 that we discovered the right combination of elements. Since refinements were made in 2014, the system has correctly called POSITIVE surprises a whopping 79% of the time with the vast majority accelerating in price.
Where to Find These Stocks
I can't share all the details of the secret formula with you, but our system relies on two under-utilized signals coming from the brokerage analyst community. These two whispers are then layered on top of other time-tested elements such as the Zacks Rank and Zacks Industry Rank to find only the best stocks... in the best industries... with the best chances of beating earnings and quickly rising in price.
If you would like to receive our precise whisper trading signals through the heart of this earnings season, I invite you to check out our Zacks Surprise Trader.
This is a significant research breakthrough, and it predicts positive earnings surprises before they are reported, with documented 79.32% accuracy. It offers you the chance to beat Wall Street to the punch by getting in early on price pops that can follow positive surprises.
In fact, our Surprise Trader portfolio has recently closed gains of +70.9%, +40.7%, +24.3%, and +43.6% in as little as 5 days.¹ So if you’d like to pursue quick, substantial profits this earnings season, and are ready to move on the positive surprises we’re predicting, then come on and join us.
Bonus: Today you may download our "Early Warning Alert" report free. It reveals Stocks to Sell BEFORE They Report Earnings in the Coming Week. Our strategy works both ways, and you can use this report to avoid companies that are likely to report the worst negative surprises from October 19-23.
Don't delay. We can't let too many share our "surprise" recommendations, so they are generally closed to the public. Today the portfolio is briefly open again, but your chance to gain access ends midnight Sunday, October 18.
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Dave Bartosiak is Zacks' resident earnings surprise expert. He selects stocks and delivers daily commentary for our Surprise Trader portfolio.
¹ The results listed above are not (or may not be) representative of the performance of all selections made by Zacks Investment Research's newsletter editors and may represent the partial close of a position.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.