The stage is set for perhaps the most important earnings season in over a decade. Stocks are on shaky ground, staging a tepid recovery after the world economy has come to a screeching halt. As the coronavirus pandemic ravages the population, entire countries are shut down. When things eventually get back to normal, the economy will emerge with a new set of leaders. A structural change is coming with new industries and stocks leading the way.
This is helping to create perhaps the single largest opportunity, and largest risk, the stock market has seen since the depths of the Great Recession. Companies which are best-positioned to profit from the new “stay home” economy will reap huge benefits, while those stuck remembering the glory days of yesteryear will see their stock prices wither away and die.
It seems that the economy and the stock market may currently be at odds with each other, but they are not. The market is always forward-looking and often times optimistic. When it comes to stocks, it’s all about the future. This brings to mind one of the most confusing things about earnings season:
Why do some stocks skyrocket on a positive earnings surprise while others fall off a cliff?
In this article we are going to tackle this little understood issue. Better yet, I will share with you two ways to profit from surprises this earnings season. More on that later.
3 Reasons Stocks Can Drop After a Positive Earnings Surprise
1) Estimates vs. Expectations: The standard definition of an earnings surprise is when actual earnings comes in higher than earnings estimates. But those estimates are the “published” numbers from the brokerage analysts. Quite often investors tend to develop their own unique set of expectations that can differ greatly from the Wall Street analysts. If there is too much optimism ahead of the release, then actual earnings will need to be a blowout in order to appease investors inflated expectations. This is the most common reason why some stocks fall after a “supposed” earnings beat.
2) Quality of Earnings: The highest quality earnings come from having robust revenue growth. This means that the company’s products or services are in high demand and should stay that way into the future. However, these days far too much of the earnings being reported is generated from cost cutting and other “accounting gimmickry”. The problem with that is that the benefits of these moves don’t last. When the market gets a whiff that the earnings are unsustainable, no matter how strong the beat, shares will most likely drop.
More . . .
Advance Notice of Positive Earnings Surprises
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3) Forward Guidance: Plain and simple, when you buy a stock you are taking an ownership stake. And what owners of companies care about is the stream of future earnings. So if a company beats earnings for the quarter just reported, but warns that future quarters will see lower earnings, then that stock will go down…and go down fast.
2 Ways to Make Money on Earnings Surprises
So now that we have outlined things that can go wrong after an earnings surprise, let's shift gears and talk about something even more important; How to turn a profit from earnings surprises. Here are two ways to go about it.
Good Way: Buy shares in any company that had an earnings surprise and rose the day following the news. These stocks experience what academics call the "Post Earnings Announcement Drift”. Studies clearly show that these stocks usually outperform the market over the next 9 months. Conversely, you should sell any stock in your portfolio that misses its earnings numbers as it likely to underperform the market for the next few quarters. The downside of this approach is that there are literally thousands of stocks to choose from every quarter.
Best Way: Find stocks where the earnings “whispers” tip you off that a big surprise is coming. Buy the shares shortly before the announcement and enjoy quick gains of 10%, 15%, 20% when the earnings surprise is officially reported.
I know what you’re thinking. There are no Magic 8-balls for the stock market, so how can this possible??? But fret not; this isn’t a magic show. It’s pure science.
The concept of finding a profitable source of earnings whispers has long been the Holy Grail of stock investing. Many experts have tried and failed to make this work. In fact, we had been researching this for countless years.
Early on we found clues that told us which stocks are more likely to surprise, but not necessarily rise in price. It wasn’t until the summer of 2010 that we discovered the right combination of elements. Since refinements were made in 2014, the system has correctly called POSITIVE surprises a whopping 80% of the time with the vast majority accelerating in price.
Where to Find These Stocks
I can't share all the details of the secret formula with you, but our system relies on two under-utilized signals coming from the brokerage analyst community. These two whispers are then layered on top of other time-tested elements such as the Zacks Rank and Zacks Industry Rank to find only the best stocks... in the best industries... with the best chances of beating earnings and quickly rising in price.
If you would like to receive our precise whisper trading signals through the heart of this earnings season, I invite you to check out our Zacks Surprise Trader.
This is a significant research breakthrough, and it predicts positive earnings surprises before they are reported, with documented 79.51% accuracy. It offers you the chance to beat Wall Street to the punch by getting in early on price pops that can follow positive surprises.
In fact, our Surprise Trader portfolio has recently closed flurries of double-digit gains.
So if you’d like to pursue quick, substantial profits this earnings season, and are ready to move on the positive surprises we’re predicting, then come on and join us.
Bonus: Today you may download our "Early Warning Alert" report free. It reveals Stocks to Sell BEFORE They Report Earnings in the Coming Week. Our strategy works both ways, and you can use this report to avoid companies that are likely to report the worst negative surprises from April 20-24.
Don't delay. We can't let too many share our "surprise" recommendations, so they are generally closed to the public. Today the portfolio is briefly open again, but your chance to gain access ends midnight Sunday, April 19.
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Dave Bartosiak is Zacks' resident earnings surprise expert. He selects stocks and delivers daily commentary for our Surprise Trader portfolio.