The Secret to Profiting from Earnings Reports
by Matthew Weinschenk
Contributing Editor, Investment U & Senior Analyst, The White Cap Report
Whenever corporate earnings season rolls around, many investors would love to play the various announcements and profit from them.
Trouble is, they don’t know how to without exposing themselves to the volatility and risk that goes with earnings season. They think about earnings reports the wrong way – and leave cash on the table because of it.
Let me explain…
The Earnings Minefield
Let’s say eBay (Nasdaq: EBAY) is set to report its quarterly earnings in a week’s time. So how can you make money from it?
To predict earnings, we can breakdown all the financial reports, study web traffic and retail numbers, project revenues and costs, and arrive at an earnings number. But chances are we’ll be totally wrong.
That entire method is fundamentally flawed. Individual investors can’t put this much time into a single stock and being off by just a penny means you could lose a bundle, since earnings estimates (no matter how arbitrary) are a crucial part of the process.
So what do you do? You watch and wait.
How You Can Claim Post-Earnings Profits
Now, if eBay surprises investors by earning more than expected, the stock will shoot up.
However, you can still make handsome profits by buying after everyone knows about earnings – even though the stock is already up.
Here’s why: after an earnings announcement, stocks don’t fully “price-in” the new information immediately. Instead, it makes an initial move, but it will then drift in a predictable direction for the next 3-9 months.
This isn’t the stock market version of an old wives’ tale. Academic researchers call it this the “post-earnings announcement drift” and have verified it statistically, time after time, for the past 40 years.
So the debate is no longer whether it exists… but why.
Post-earnings announcement drift baffles researchers. They say that profitable opportunities as simple and reliable as these simply shouldn’t exist in a so-called “efficient” market.
Fortunately for us, they do.
A Dozen Ways To Identify An Earnings Cash Cow
You should watch for earnings surprises as a powerful first screen for finding promising stocks. Or, if you were considering buying a particular stock that just disappointed the market, think twice. You’ll be fighting a strong tide that wants to pull it downwards.
The important thing to remember is not to give up on a stock that just jumped in price thanks to higher earnings. The best is often yet to come.
Ahead of the tape,
Matthew Weinschenk
Related Investment U Articles:
- Using the Post-Earnings Drift: How to Find Stocks Set to Surge in Two Easy Steps
- The Five Horsemen of the Economic Resurgence
- Never Trust a CEO Who Does This…
- Five Reasons Why the S&P 500 Will Hit 1,350
- Cash Flow: One of the Most Accurate Ways to Analyze a Stock’s Value
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Sir,
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