How Do I Play Earnings Season?

 

(Earnings) Seasons Greetings!

How to Play Earnings

November IPO that’s Already More than Doubled

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Two weeks ago, Alcoa (AA) served up its Q4 results for the investing world to see. If the stock-investing world has an equivalent of the swallows coming back to Capistrano (which signals the arrival of Spring) or Mardi Gras (which marks the beginning of Lent), it’s Alcoa’s earnings release, which means we’re in for another round of Earnings Madness.

For some reason, tradition or competitive spirit, perhaps, Alcoa is traditionally the first big company to drop its numbers every quarter. This time (Q4 and full-year 2013), the news came out after the market closed on January 9. As usual for Alcoa, that’s pretty quick work after a quarter-end. [The news from Alcoa was not all that great: a loss of $2.19 per share, which translated to a earnings of four cents a share after all the special items were removed. Analysts had expected six cents, so the stock took a hit. But just fyi, AA has been soaring since then on a nice combination of an analyst’s upgrade, cost cutting measures and good demand for aluminum. So it goes.]

I’m going to give you a quick walk through the world of quarterly reports (a “backgrounder” as they say in the news biz) and list a few rules that will let you get through a year’s worth of earnings without blowing a gasket or reducing your portfolio’s value too much.

WHY EARNINGS SEASON?

Why is there an earnings season? It’s because the Securities and Exchange Commission (SEC), which writes the rules for equities listed on U.S. stock exchanges, says so.

According to the SEC, every publicly traded company has to file a Form 10-Q (for quarterly) unaudited financial statement for each of the first three quarters of the company’s fiscal year. And at the end of the fiscal year, there must be a 10-K report, an official, audited disclosure of all significant financial information.

Just as a side note, there’s really no reason for a company to have its fiscal year conform to the calendar year. Many retailers have fiscal years that end in January, which gives them until February to clean up after the holiday season, get their inventory straight and do their books. In fact, companies’ fiscal years end in virtually every month. Maybe they get a discount on their auditing for avoiding the peak season?

Big and medium-sized companies get 40 days from the end of the quarter to file. Small companies (market cap of $75 million or less) get 45 days. Annual reports are due within 60 days of year’s end from companies with a market cap of $700 million or more, 75 days for companies whose market caps are $75 million or more, but less than $700 million, and 90 days for small caps (less than $75 million).

EARNINGS HITS AND MISSES: SO WHAT?

Most of the evidence that equity investors use to decide on which stocks to buy is probabilistic. There are no guarantees. A company that has been growing revenues and earnings quarter after quarter may keep the string going … or may not. And a stock with a low P/E ratio and good growth prospects may be ready to start climbing … or not.

But earnings season, when investors compare companies’ results with the “consensus numbers” (an average of the estimates of all the analysts who are following that company) is generally pretty clear in its verdict. If a company is supposed to make a nickel per share but makes six cents, that’s a beat. Everyone’s happy. If revenue was supposed to top $200 million but the report says $199 million, that’s a miss. Nobody’s happy.

Hitting the consensus numbers generally supports a stock’s price. Exceeding the number often leads to a jump in price, including the “gap up” that investors love to see. A stock that pops higher on the day after earnings (especially if volume has also spiked higher) often gets a dose of momentum that will power it to further gains.

Here, for example, is a chart of Harman International (HAR), a maker of audio equipment that’s been making big moves on the strength of its infotainment systems for cars, mobile devices, high-end home systems and every kind of venue up to concert halls and sports stadiums. Harman had great Q2 and Q3 earnings reports, and you can see their effects in the high-volume moves in August and late October. Harman will report results for the latest quarter on January 30, and it’s possible that another analyst-beating performance will kick off another rally. (This report will reflect Harman’s fiscal second quarter of 2014, so no full-year results will appear.) The release will happen before the market opens, and there will be a conference call at 11:00 EST to talk things over.

There are exceptions to all of these rules, of course. If management gives a convincing reason for the miss, or issues positive guidance to future performance, the damage can be contained, or even reversed.

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SO, HOW DO I PLAY EARNINGS SEASON?

The way to play earnings season depends on whether or not you own the stock whose report is coming up.

If you own the stock, you have four choices:

1.You can just hold through the news and trust to luck. If the stock goes up, you’re a genius. But the converse is also true.

2. You can sell part of your position ahead of the report. If you have a profit, this will lock part of it in, while still giving you exposure to a possible advance.

3. You can set a loss limit on the stock, which may get you out of the position with less damage. The problem here is that a disappointing report, especially one that comes out after the market closes, can produce an opening price the next day that’s below your stop.

4. You can buy an option that will allow you to make money even if the stock tanks. 

If you don’t own the stock, you also have three choices:

1.You can buy the stock (or short it) ahead of the report. This is the least attractive option, as you have no real idea of how likely the report is to beat expectations. It’s a little like playing Red on a roulette table.

2. You can wait for the report and then jump in quickly if the stock gaps up on good volume. Our research shows that a stock that gaps up on volume usually gets a longer-lasting boost that will keep pushing it higher.

3. You can buy an option that will give you a profit if the stock reacts big either way.

My own preferred way to play earnings season is not to play it at all. I keep track of when reports are due from the companies whose stock I own and then pay close attention to the reaction to the news. By using my usual loss limits, I can limit my downside, although a big miss can still hit hard enough to leave a mark. But if you’re picking good stocks, your gains will outweigh your losses over time.

If you want to know when your companies are reporting, the most reliable guide is the Investor Relations area on the company’s website. You can also try websites like Yahoo Finance. Go to the specific page for your stock and look in the left-hand column for “Company Events.” Just remember that any date for an earnings release that isn’t accompanied by an official message from the company itself is likely just an estimate of the predicted week for the report.

Good luck with your holdings this earnings season.

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For my stock pick, I’m going to go completely over the top and give you a stock that I’ve been following with mixed interest and disbelief. The company is 500.com (WBAI), a Chinese online sports lottery company that doesn’t have an equivalent in the U.S., as far as I know.

The company came public just in November, and has already more than doubled in price. So that must count for something, right?

Well, yes, it does, but 10 weeks of price history isn’t enough to qualify a stock for a serious buy. So I’m just recommending that you put 500.com on your watch list, kick the tires occasionally and wait for it to form a post-IPO base and get through its first earnings season before actually taking a position.

I don’t think I can improve on the company’s own description of what it does, so here it is, verbatim.

Company Profile

500.com is a leading online sports lottery service provider in China with the largest market share in the six months ended June 30, 2013 and the second largest market share in 2012 in terms of purchase amount of sports lottery products, according to the iResearch Report.

The Company acts as an aggregator and processor of lottery purchase orders from its registered user accounts and currently derives substantially all of its revenues from service fees paid to 500.com by provincial sports lottery administration centers for the purchase orders of sports lottery products that are directed to such centers. 500.com offers a comprehensive and integrated suite of online lottery services, information, user tools and virtual community venues to its users.

The Company is among the first companies to provide online lottery services in China, and is one of the two entities that are authorized by the Ministry of Finance to provide online lottery sales services on behalf of China Sports Lottery Administration Center, the government authority in charge of the issuance and sale of sports lottery products in China. Through continued and significant investments over the past 12 years, 500.com has built a prominent brand, 500wan, which means “five million” in Chinese and is the typical amount of top prizes of most lottery products in China. 500.com believes its brand is known in the industry and by our users for its credibility and reliability.

500.com came public after a great Q3 earnings report that showed revenue up 208% and an after-tax profit margin of 18.0%. With a little more seasoning, this could be a great investment. Even without a substantial history, investors have been bidding the stock up.

But I’ll stick with lower-risk recommendations for my Cabot China & Emerging Markets Report. The Report scored a 50.1% gain in 2013, according to Hulbert Financial Digest! 

You can try it out for yourself by clicking here.

Paul Goodwin

Chief Analyst of Cabot China & Emerging Markets Report
and Editor of Cabot Wealth Advisory


Paul Goodwin can be found on Google Plus.

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