Four times a year investors seems to have a habit of losing their minds.
When the companies in their portfolio report their quarterly earnings, the market often reacts with large swings up or down. This can lead to poor decision making on the part of investors who may react impulsively to an earnings announcement that really does not affect the big picture.
To help guide you through the upcoming earnings season, Vuru has some tips on what to think about when the companies in your portfolio announce their results. Investors should remember that earnings season may not be an adequate representation of a company's value, drastic changes in stock prices tend to not represent the underlying value of a company.
Its Never as Good or as Bad as it Seems
Whether your company missed, met or exceeded the expectations of the analysts that cover the company, markets tend to go crazy over the announcement. Often stock prices will drastically spike or drop minutes after the announcement as investors and speculators think about how the company is changing.
However it is important to realize that often these gains or losses are only temporarily. Investors realize that beating earnings by 5% more than expected shouldn’t cause the company’s shares to rise more than 5%. Most of the stock price increases related to beating earnings are lost in the coming days as speculators move in and out of the stock. The same also holds true for companies who miss earnings. They tend to gain back some of the losses in the coming days.
As well, around earnings seasons day traders, hedge funds and other speculators will take positions in companies that they think will release earnings different from analyst’s expectations. These groups will cause dramatic stock price swings that could take some time to get back to normal. Waiting through this time frame is likely the best idea.
What's the Big Picture?
Value investors realize that one earnings announcement isn’t the make or break for a company. With a long-term horizon and a focus on finding companies that are undervalued, value investors really need to look at the big picture, especially around earnings season.
How does the company announcement change the big picture? A poor result does not necessarily affect the potential for a company moving forward. Investors should think of these annoucements as data points. Each annoucement adds another data point to the information the investor has on whether or not the company is worthy of investment. A really bad winter may have lead to a poor earnings result, but that does not mean that the company is set up poorly for the future.
How does this fit in the larger trend? This data point, along with the past announcements sets the picture that investors should look at when considering companies they own and companies they would like to purchase.
Companies Manage Earnings
Company Chief Executive Officer’s understand that the earnings of the company, in relation to what analysts expect, can lead to large changes in the price of a company’s stock. CEO’s also get large percentages of their compensation in the form of stock and stock options. They have the incentive to ensure that the company’s earnings are “managed” to make sure that investors are not taken off guard and the stock price does not drop more than necessary.
This bias can lead to some less than ethical accounting practices and to CEO’s using their statements to guide the expectations of investors and analysts. Understanding these facts can help investors from making poor decisions during earnings season.
Investors should always take a stepback during earnings season and consider why they invested in the companies they own in the first place. How does the recent annoucement affect their original investment criteria? If the answer is not at all, investors should not worry about short-term changes in the stocks of companies that they own.