Earnings season is one of the most exciting times on Wall Street.
Thousands of publically traded companies hope to impress investors with their quarterly financial reports. In the same vein, retail traders often look at this event as a chance to ride quick price moves, especially if the company beats analysts' earnings per share (EPS) expectations.
If a company can produce higher numbers than external forecasts, they are likely to turn heads. And while it's important to note that traders and investors should carefully consider the entirety of a company's quarterly report, EPS is often the key performance indicator.
You may think that a stock price would jump every time a company delivered an EPS above analysis' estimates. But, solid earnings announcements don't always translate to big stock moves... sometimes, they can do the opposite.
What Is An Earnings Surprise
The Security and Exchange Commission (SEC) requires publically traded companies to disclose financial data in quarterly and annual reports. This information includes a balance sheet, cash flow statement, income statement, and other pieces of important information.
EPS is the company's profits divided by the number of outstanding common shares. Simply put, this value is the amount of money that the company makes per share.
EPS = Profits / Shares of Common Stock
While investors do not have access to earnings as profit, EPS reflects the company's growth potential, value, and performance among industry peers.
Throughout the fiscal year, analysts from various institutions will attempt to forecast the company's performance using industry data, management interviews, and competitor financial statements. Analysts will publish their estimated quarterly EPS for stocks they are covering with the hope of matching the company's actual reported number.
An earnings surprise occurs when the company's actual EPS comes in above or below the analyst's expected EPS.
Surprise % = ( (Actual - Surprise) / Actual ) x 100
How Earnings Surprises Can Greatly Impact Price
When a company's EPS comes in significantly above or below analysts' expectations, the stock price can quickly move in the direction of the surprise. It's not uncommon for a 10-15% run to follow a surprise announcement.
However, it's important to note that this phenomenon does not always occur. There are many reasons why a stock price could stagnant or tumble even after a company's EPS greatly exceeded analysts' expectations.
Forward guidance, revenue gains as a result of cost-cutting, industry trends, and change in management, among other things, can all lead to a massive drop even after a stellar earnings surprise.
The same is true for a negative earnings surprise. Even if a company fails to come close to analysts' forecasted EPS, the stock price could soar. Many factors weigh on investors' sentiment during earnings season.
Avoid The Surprise Fallout
But, the question is... how do you avoid those fallouts even when earnings greatly exceed analysts' estimates?
How do you harness the power of earnings and ride the awesome moves that can follow this positive corporate indicator?
A comprehensive look at full quarterly financials can show the true view of a company's growth and potential for many traders and investors. However, these reports can be many, many pages. On top of that, investor relations teams will try to keep a positive tone even if the company's future is grim. It may be challenging to consume this information, particularly if you're diversifying your portfolio with equities in non-correlating markets.
However, looking at the company's technicals in addition to a surprise announcement can help find stocks with positive price potential.
How To Play Earnings Announcements
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We've turned a well-documented market phenomenon, known as the post-earnings announcement drift (PEAD), into a set of tools you can use right out of the box.
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