Investing Prior to Earnings Announcements
Some investors hear of upcoming earnings for a company and begin thinking about putting some of their hard earned money into the company. Perhaps its a stock like Apple or Google which often captures a lot of media attention around earnings announcements. The expectation is this: The company’s earnings will exceed expectations and, therefore, the stock will rise giving investors an immediate reward for their investment. Have you ever made a new purchase of a stock based on this expectation?Yet investing prior to earnings, even with the so-called reliable big-name stocks, is extremely risky. In fact, let’s call it what it really is: A Gamble! You have no way of truly knowing what the company will report (nor do the analysts as we discover)… all you have is an approximation. Yet, even if they exceed the analyst guesses on numbers like Earnings per Share (EPS), which is one of the most recognizable and widely reported financial number of a company, their future expectations might paint a less attractive picture. It’s like the old woman/young woman picture of investing. One perspective paints a picture of a stock with longevity and promise while the other displays less hope and more “best days behind” considerations. The emphasis for investors should never be on what a company has done, but what it is going to do. Why invest in a company that has a great history, but little future growth, sales and revenues. That’s a museum… and you won’t get much out of it.
So investing prior to earnings is, in many cases, a gamble. Most investors that engage in that practice are hoping for good results and a reward for their short-term trade. If you guess right, you will be rewarded for your gamble… but if you don’t, watch out… the stock price will likely fall significantly.
Examples of Earnings Earthquakes
Well, since we’re talking about Apple, let’s take a look at the past couple of earnings announcements. Certainly, this company has a great reputation with plenty of earnings announcements that have beaten expectations. Yet, they’re not perfect. Consider October 18th, 2011… when they announced earnings and future forecasts that caught the markets off guard a little.
- The stock, had you bought on the 18th, closed at $422.24.
- The next morning, it opened at $401.00, a 5.3% decline.
- The stock proceeded over the next couple of months to dip to as low as $363.32, a 16.2% decline.
Recently, Apple had a more impressive result, with revenues climbing and EPS at all time highs. Cash was flowing from the consumer to the company and shareholders alike. Yet, despite their impressive results and the gap up in their stock price, something interesting happened. Their stock price dropped the day after the earnings announcement and the next day too. So investors that took a gamble on Apple this last earnings report might have experienced something like this:
- Apple closed January 24, 2012 at $420.41.
- Apple opened January 25, 2012 after the earnings report at $454.44, a 8.1% leap.
- But immediately, the stock began dropping… closing January 25, 2012 at $446.66, a 1.7% decline.
- So, for investors who heard the earnings January 24th and bought in before or at the open on the 25th, they lost money instantly.
Let’s take a moment to look at one other stock… Google. If you take a peak at their daily chart, you’ll see lots of gaps in their day-to-day stock price… we refer to these as gap-ups or gap-downs depending on the direction. Often around earnings, you’ll see these gaps… leaving investors with significant rewards or losses overnight… and there is nothing they can do about it.
- July 14, 2011 – Google sees a huge gap up in stock price from $528.94 to $597.50.
- October 13, 2011 – Google sees a modest gap up in stock price, from $558.99 to $599.47, followed by lots of volatility. Notice again that those purchasing the day after earnings would have had an immediate loss from the open of $599.47 to the close that day of $591.68.
- January 19, 2012 – Google sees a huge gap down in stock price from $639.57 to $590.90 followed by 3 more days of declines.
If you apply the principles of risk management to buying stocks around earnings time, you’ll avoid taking these big risks (which is really gambling) and apply a more disciplined and less emotional approach to investing. Whether the earnings disappoint or even exceed, it’s risky to assume the stock price will rise. Even waiting a day, to purchase the stock after the earnings are announced, may lead to unnecessary risk as we saw the day or two after the latest Apple results.
In a couple of days, we’ll look at what investors can do to manage risk around earnings results when they already hold the stock. But in the meantime, if you are considering investing in a stock just prior to or immediately after earnings are announced, just remember: Trading stocks around earnings announcements, even stocks as great as Apple, is an investment decision saturated with risk.