Why Overreactions to Out Of Season Earnings Create Opportunities for Investors

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One of the things that often surprises those new to trading and investing is that there is no set time or period of time for companies to report earnings. There is an earnings “season,” the month or so following the end of the calendar quarter when the majority of companies report, but they are not required to do so on that schedule. Each company sets the beginning and end of their own financial year and when their quarters end. While most do so in a way that fits the annual calendar, some do not. There are, therefore “out of season” earnings, and their standalone releases often create trading opportunities based on the level of scrutiny they receive.

During earnings season, there are sometimes dozens of companies reporting on any given day, with their stocks reacting accordingly. One of my personal favorite trades at those times of the year is to fade that reaction, because it is so often exaggerated even then. It is not that the reports aren’t good or bad, it is just that the reaction is way too big. That leads to opportunities in stocks like Sofi (SOFI), one that I talked about a month ago, when that stock dropped to around $4.60 on a miss of expectations, then bounced back, gaining more than 20% in four trading days.

There are a couple of things that make for that exaggeration: the extreme focus on the short-term that comes with reacting to one quarter’s results or outlook, and the fact that there are multiple traders attempting to trade that reaction in thin, out of hours markets. If the second part of that is true when dozens of companies are reporting every day, imagine how true it is when, outside of earnings season, there is only one or two per week, if that. There are the same number of traders looking to react to news, but a lot less news, so the reaction to each announcement or report is even greater.

We are seeing the impact of that this morning in the reaction to earnings and outlooks from two companies in very different industries, the AI focused semiconductor maker Ambarella (AMBA), and the auto parts supplier Advance Auto Parts (AAP). Don’t get me wrong, both companies produced disappointing reports in one way or another, and both lowered their full-year guidance, the thing that usually has the biggest impact on a stock. These were bad earnings reports, but do they justify around a 20% drop in AMBA and around 30% in AAP? One could argue not.

Ambarella actually beat estimates on the bottom line, with a loss of $0.15 per share, better than the $0.20 loss anticipated, but cut revenue guidance for the whole year significantly. They put that expected weakness down to “cyclical headwinds,” and the key word there is “cyclical.” That implies that it is a temporary cutback by customers rather than that they are operating at a big competitive disadvantage. There is an element of “Well, they would say that, wouldn’t they” but there is no reason to believe that not to be the case. In fact, part of the reason for the loss is Ambarella’s big investment in R&D, particularly in products designed for the AI boom. That particular pie looks like it will be big enough for everyone’s slice, so while the cost of that R&D in a cyclical downturn will weigh in the short-term, it looks entirely justified.

The story for Advanced Auto Parts is different but is also about short-term headwinds that can be expected to turn. Their issue this quarter was that cost increases and consistency in supply were proving much more persistent than the company or analysts predicted. That creates a problem in an industry as competitive as theirs. It is easy for customers, both individuals and within the auto-repair industry, to research pricing and order elsewhere if that is justified, so offsetting input cost increases by raising prices isn’t easy.

Still, that same dynamic of supply issues is continuing to impact new car production and pricing, creating an environment where repairing an older vehicle is much more attractive than selling or scrapping it. That will, at some point, allow the industry generally to price parts more advantageously, but the reaction to AAP’s earnings this morning doesn’t reflect that reality at all.

As tends to happen in the immediate aftermath of isolated earnings reports that have bad elements to it, both AAP and AMBA are seeing significant declines. Investors, however, should ask themselves how much of that is down to the actual news, and how much is down to traders with limited opportunities piling into an obvious trade. With twenty and thirty percent drops on what are bad but not disastrous earnings reports, it looks like the latter is at play here, and that means that while both stocks may stay down for a while, in the long term, both will prove to have been buys at these levels.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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