Market Overview

How To React Instead Of Predicting This Earnings Season

How To React Instead Of Predicting This Earnings Season

Starting on Thursday with the Alcoa report, traders will enter the quarterly craziness known as earning season.

Trades are going to queue up their orders to bet on which companies will exceed or fall short of the always highly accurate analysts' estimates. Companies that disappoint will see billions of dollars of market cap just evaporate in the trading frenzy.

Those that beat the estimates will suddenly be “worth” billions more than they were the day before. Complex option bets designed to benefit from surprises will be structured and placed, especially on the high flyers of today like Netflix and Amazon.

It is like a Super Bowel every day for the active trading community.

So should we all be rushing in to get our act together and study the earning surprise history of companies like American Express and Morgan Stanley that report next week? Should we be making bets on what we think will happen at the money center banks like Bank of America and Wells Fargo in advance of their earnings report?

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The big tech names like Apple, Intel and IBM report in the last two weeks of the month. Should we be structuring complex options trades to take advantage of a potential earnings surprise?

The game has started, shouldn't we be playing this earning season?

For the vast majority of us the answer is no. In the super bowl there will be 106 guys on the two teams who make the game time roster. Twenty-two of them will be the very best at their positions and the remaining will be almost as good or have some very specialized role on the team.

There will be amateurs of part time players on the field when the whistle blows. It is exactly like that when it comes to short term trading, especially during earnings season. A handful of traders will use sophisticated techniques and draw upon their deep levels of experience and make money trading earnings related volatility. Almost none of the will be part time traders.

Much like an attempt for most of us to suit up against NFL players our attempts to beat the professional short term traders is going to end up in a lot of pain if we insist on trying to play their game.

That is not to say there is no opportunity for individual investors in earnings season.

If you have adopted a deep value approach to investing there can be a few pleasant outcomes from this craziness. If you already own a portfolio of undervalued stocks they are usually companies that have not had stellar short term results and any positive news can lead to a swift jump in price as traders pile into the stock. Particularly in the smaller stocks that deep value investing favors this can lead to a huge move in the stock in the days and weeks following the announcement and allow you to take outsized profits in formerly cheap stocks.

The really exciting thing that happens pretty much every earnings season is the creation of long term buying opportunities.

Every quarter is seems some company will miss the analysts estimate or whisper expectations and see its market cap destroyed losing one third of more of its value.

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Often we will be able to buy shares of company with a strong asset base at a discounted price because of the short term over reaction of traders and large funds. A quick screen shows that there are more than 700 companies trading between 1.0 and 1.5 times book value that could quickly become buy candidates if they were hit with a strong wave or earnings related selling. It is highly likely that 1 or more of them will disappoint the Street and end up in our deep value asset based portfolios during the silly season.

It is highly unlikely that any of us not already in the NFL will play in the Super Bowl.

It is also highly unlikely that any of us who have full time careers, families and other interests are going to make out fortunes as short term traders. This is particularly true during earnings season when the few professionals traders who are successful have their sophisticated models and strategies set up specifically to exploit our amateur efforts.

There is far more money to be made by reacting to earnings season and taking advantage of excessive reactions that create opportunities to sell over valued stocks and accumulate those that are suddenly cheap.

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