Earnings Announcement - Stocks reaction

In the United States (U.S.), public limited companies are required by the Securities and Exchange Commission (SEC) to publish their financial statements every quarter (10-Q reports).

The majority of the companies do however officially announce their performance weeks before the actual 10-Q reports are submitted. The reason for this is that the market would be in anticipation for their earnings data.

Quarterly earnings announcements are much more important than the actual financial statements since during these conference calls investors are made aware of the fact whether the company has actually managed to beat market expectations and if there is a change in future guidance (i.e. change in future earnings).

What do we seek to achieve from the earnings data?

First of all we get to know the company’s revenue (i.e. gross sales) and thereby understand if the company managed to increase their market share.

The actual earnings (i.e. profits) will show a smaller number since this is basically the revenues less any expenses. An important metric to look at is the Earnings per Share (EPS) which is the net income divided by number of shares outstanding and shows the per share version of how the company is doing (i.e. profits per share). EPS gives us an idea of how the company is growing overtime however we need take note of some pitfalls associated with this measure. When constructing financial statements, accountants might use what is called ‘accrual accounting’ which means that some items on the balance sheet are being recorded when the transaction actually takes place and not when the physical cash is paid. (e.g. money still to be received is already considered).

During conference calls traders and analysts will also be eagerly waiting to know if the company will change its forward guidance. This is considered very important since, unlike the EPS or revenue data which is reporting something historic, guidance is what will drive the price in the future as they will be reporting something that is still ‘unknown’.

How do stocks move after earnings?

The below are tables showing the 30 best and 30 worst performing S&P 500 stocks price movements following their earnings announcement. What we can notice here is that whenever the results managed to beat market expectations, in the majority of cases we saw a huge rise in price whereas when firms missed expectations or got their guidance lowered or in-line we saw huge declines.

Interesting to point that the market always reacts positively when there is a surprise, that is when expectations have been beating or guidance is improved (the contrary if expectations are missed and guidance is lowered). Prices tend to decline even when results are in-line because this is already priced in the market so no changes are expected.

Earnings conference calls are very important and it is crucial that these are followed both if you are already holding the stock or thinking to invest in it  (see link for earnings calendar)

These announcements generally provide a good opportunity for investment as we would usually notice major fluctuations depending on the outcome. (See our previous articles following earnings announcements on Facebook, Apple, Tesla and RBS).

 

Table data source: Bespoke Investment Group

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