Most traders and investors are aware of the fact that each financial quarter, companies release their earnings reports. Although, an earnings report includes many important financials about the company- including net income, revenue, expenses, earnings per share, and net sales- the general idea is that, by releasing an earnings report the public is made aware of the general performance of the company.
Shareholders of a publicly-listed firm have a vested interest in knowing how the company performed during the quarter; after all, their money is on the line! Potential investors also have a vested interest. Is it the right time to buy, or should the investor wait until the company shows more consistent financials? Investors are usually looking to buy and hold shares for the long haul, so before placing any money on the line they want to ensure that they have done their homework thoroughly.
But what about active traders who are used to getting in and out of trades quickly? They don't care much about a company's long term potential; they just want to make some quick money. Is it actually possible for there to be a way to take advantage of an earnings report to generate some quick, short-term profits?
The answer is a strong, resounding yes.
The magical price drop
Take a good look at the above graph of Mahindra & Mahindra Financial Services. It is a one day, intraday graph for the 22nd of January. From market open (9:15am) through approximately 2:15pm, the stock's price hovered around 270.
And then the stock's price fell.
What caused the fall? By now, you could have probably guessed the answer. Right around 2:15pm, the company reported its earnings results. The key financials that the market usually looks at are earnings per share (EPS) and net profit. Analysts polled in advance had expected M&M Financials to report a net profit of approximately Rs. 240 crore on a year to year basis, but the actual number came in much lower at Rs. 164 crore. The market did not hesitate to sell the stock, and by the end of the day the price had fallen from 270 to 253. After the news soaked in overnight, the market sold the stock heavily on the 23rd as well, with the stock's price closing at 239.9.
On the 22nd alone, if an acute trader had sold the stock at 270 and bought it back at 253 at the end of the trading day, he would have earned a profit of (17/270) = 6.2 per cent return on investment. That is an absolutely incredible return on investment on a trade within one day.
And if there is any doubt that traders not investors, were the ones that caused that massive drop in price, the following table should put those doubts to rest.
As you can clearly see, the volume spiked up on the 22nd and 23rd. Incredibly 1.4 million shares were exchanged on the 23rd, while the average from January 1st through January 21st was approximately only 100,000. Clearly traders were getting in and out of trades and exchanging shares furiously.
So the question remains: how does one exactly go about earning from earnings reports?
Speed is the name of the game
Similar to trading economic news releases (see my post here on how to trade news releases), one needs to ensure that they get their news in a timely fashion. Subscribing to real-time news outlets like Bloomberg, Reuters, or wire agencies like PTI (Press Trust of India) or Business Wire India is the best bang for the buck.
By doing so, you would get real-time RSS feeds with the latest breaking news, including relevant earnings reports and their associated financials.
The idea is to the get the news as soon as possible. Otherwise, you can try to stay up to date through live TV and the internet, but there is a chance that you will get the information in a delayed format.
Here is a step by step guide to trading earnings reports:
- Be prepared in advance. Know which earnings reports are due on which day. Refer to a results calendar to know which important earnings reports will be released.
- Ensure that the earnings report you want to trade is being released during market hours. Many times, companies release their earnings reports after-market hours; in that case, it becomes much more difficult to trade the report. Stick to the stocks whose earnings reports are released during the day. You can find out when an earnings report is due by researching the company's website. Earnings reports are usually released through a press release, so find out when the company is planning on issuing its press release.
- Know what the analysts are expecting beforehand. Stock prices move based on analyst estimates, not just on the actual earnings numbers being reported. A company might report great numbers compared to its previous quarter, but if it falls short of analyst estimates its stock price will fall. In order to find out what analysts are expecting, you will need to do some homework. There are plenty of websites that publish analyst expectations before earnings reports are released.
- When the report is released, focus on the key financials: Net income and earnings per share (EPS). If you notice a large difference between what the analysts were expecting and the actual number, get ready to place your trade.
- Always place limit orders! Never place market orders around the time an earnings report is released.
- Ensure that before placing your trade, the price has not already moved. Using the above example of M&M Financials, if you are placing your trade at a time when the price has fallen to 260, it's probably not wise to place the trade. Other traders have beaten you to the trade. As the old adage goes, "It's better to be safe than to be sorry".
- Have a stop loss and profit objective in mind before placing the trade, and stick to them diligently. As soon as either price points are hit, exit your trade. Becoming a disciplined trader involves not only setting rules to your trading system, but also following them without letting your emotions get in the way.
In conclusion, since this is the earnings season, don't hesitate to employ this strategy. Using small quantities and a conservative risk management approach, you can slowly build confidence.
After all, what good is it to study an earnings report if you're not earning from it?
Raghu Kumar is the co-founder of RKSV, a leading low-cost broking firm. The opinions expressed here are the personal opinions of the author. NDTV is not responsible for the accuracy, completeness, suitability or validity of any information given here. All information is provided on an as-is basis. The information, facts or opinions appearing on the blog do not reflect the views of NDTV and NDTV does not assume any responsibility or liability for the same.