The vast majority of public companies use a calendar year for their corporate financial reporting period. The Securities and Exchange Commission requires these companies to produce a 10-Q or quarterly report every three months. The first quarter of a calendar year-end reporting company would be January, February and March. Thus, the company would have 45 days from the end of March to file their 10-Q with the SEC. These much anticipated financial announcements certainly have an instantaneous effect on the stock’s price. We are currently in the midst of first quarter earnings season.
A pattern is emerging this season where shareholders find that stocks are giving them the “head fake” move. This move gets its name from similar head fakes taking place currently in the NBA. Almost all companies report their earnings after regular market hours (NYSE: 9:30-4:00). Thus, the initial action in response to such earnings is in the after or extended market, which can be after the 4:00 pm close or before the 9:30 am market open. Either way, the head fakes are the same.
So what is it? Stocks will pop up on the initial report, and will drop thereafter. “The average stock that has reported has opened higher by 0.48 percent after its earnings report. After the initial pump fake higher at the open, though, things have turned ugly,” according to Bespoke Investment Group.
As the story goes, buy the rumor sell the news. With over 75% of companies beating earnings expectations this quarter, the above chart is very indicative of what is happening in the marketplace. Several strategies have been used in the past by investors in this type of market:
• Buy Stock Pre-Announcement: Most conservative investors will not want to do this, because it can essentially be gambling. However, if 75% of stocks are gapping up and beating expectations, then 3 out of 4 will be higher by .48% after earnings, according to Bespoke Investment Group.
• Sell Stock at Open of Regular Trading Hours: As also expressed in the chart above, these same stocks that gapped up in extended hours will come back to earth by falling .81% from the market open to the close.
One would think that stocks with strong earnings that beat analyst expectations would be a good thing. We have seen that in the micro perspective this is not the case. “From a macro perspective, we view this type of action as a bearish signal” and “we would certainly avoid chasing any stocks that are initially trading higher on earnings,” writes Bespoke. The Dow Jones Industrial Average has traded down from its April 17th high of 24,786.63. The short term micro perspective of Bespoke is spot on now. Time will tell if their bearish belief will come to fruition.
Earnings seasons are exciting times for investors, both long and short term. If you are a Warren Buffett buy and hold investor, you don’t take much stock in knee-jerk market reactions to these quarterly events. However, if you are a short term trader, these can often be a great time for you to be active in the market.