Trading is all about exploiting the right information at the right time. If you learn how to use it to make more informed trading decisions, you might be able to improve the profitability of your trading strategy.
Learning about the financial health and growth prospects of the companies you target is a good start to taking your stock trading to the next level.
Around the end of each fiscal quarter, publicly-traded companies release key metrics about their quarterly performance. These figures are very useful for traders and investors to decide which companies are worth investing in and which aren’t, based on their financial reports.
This period is called the earnings season.
While the 4 earnings periods of the year usually follow the annual calendar, some companies follow their own account periods. Still, you can expect the majority of companies to publish their business results early-to-mid January for Q1, early-to-mid April for Q2, early-to-mid July for Q3, and early-to-mid October for Q4.
Let’s have a look at the reasons why you should carefully follow the earnings season, what you need to focus on and how you can take advantage of these periods in your trading.
Why is the earning season so important for traders and investors?
When a company is listed on a stock exchange, it must adhere to a duty of transparency and information disclosure, especially when it comes to its performance. The earnings season is, therefore, the moment when public companies publish numerous quarterly, half-yearly or annual financial information to comply with their legal obligation.
This is an important time of the year for traders and investors, as they are able to appreciate the financial state of public companies. They can then determine how profitable the companies they monitor are, and know more about their growth potential, so they can decide which ones to add to/remove from their portfolios.
Because these releases are one of the most important drivers of individual stock performance on the stock market, earnings season can strongly influence the stock price of companies - and by extension the stock market.
What should you focus on?
The following figures are among the most important quantitative information you should be aware of:
- Net revenues = total amount of sales or revenues minus all costs and expenses. As it represents the net profit or loss of a company, it shows how profitable a company has been in the analyzed period. In general, the higher the net revenue, the more capital the business may be able to dedicate to investors in the form of dividends. This also means that the company can finance its own projects, without having to increase its debt.
- Earnings Per Share (EPS) = net revenues divided by the number of outstanding shares. This figure reflects the amount of profits that can be distributed to shareholders. The EPS is also useful when comparing a company's performance to that of other firms in the same industry to see which one offers the most profit.
Gross revenues, sales, EBITDA, cash flow, and level of debt are other interesting financial metrics.
But financial information isn’t the only thing you can get from a financial report, as there are different things you should track and analyze during the earnings season, such as management assessment and guidance about upcoming projects to support growth or disclosures about market and financial risk exposures for instance.
Another important thing to focus on is experts’ forecasts.
Because they’re based on empirical data and market experience, they create strong expectations among market participants, and any results not in line with analysts’ forecasts will usually generate a big price move.
How to use the earnings reports in your trading
You can approach the earnings season in two different ways - a short-term one (trading) and a longer-term one (investment).
Trading
Earning announcements very often come with higher volatility and sometimes uncertainty, which suits traders with a high-risk tolerance. This volatility can create unique trading opportunities if you have a sound trading plan and use the right tools and products.
Usually, stock prices go up with positive and/or better-than-expected reports and go down with negative or lower-than-expected figures, so you can trade stocks according to their performance relative to estimate. Some traders also like to play the odds by opening a position before the earnings release.
In any case, there are financial derivatives like CFDs (short for Contract For Difference) that are useful to take advantage of bullish and bearish market conditions with margin and leveraged trading to take advantage of short-term opportunities.
Investing
The earning season is also a great time to review your investments and spot opportunities you could take advantage of over the longer term.
Depending on the way companies have performed over the last analyzed periods, you might decide to close some of your positions to lock in profits (or limit losses) and/or add new companies to your portfolio.
Earning reports can also help you spot leading industries. You can either buy well-known companies from this industry or focus on lesser-known firms of the same sector of activity.
The earnings season is, therefore, always a good time to rebalance your portfolio to stay on track with your financial goals and be sure you’re always in line with the level of risk you’re comfortable with to reach these goals.
Some investors like to take advantage of short-term movements to hedge their longer-term positions.
A few things to remember when trading the earning season
- Select the companies you want to focus on
- Do your research to understand them, know analysts’ forecasts and analyze historical data
- Find a reliable company earnings calendar to know when earnings reports are due
- Be aware of “bellwether stocks”
- Always take into consideration market expectations, but don’t rest easy with them
- Learn to look beyond the consensus
- Make your own forecast to be able to determine what direction you think the stock might follow
- Try to understand why a company missed the target to look beyond the sell
- Understand how individual earnings surprises (whether positive or negative) can impact the trend of a stock price
- Expect the unexpected
- Actively follow company-related news around the earnings announcement
- Watch/listen to earnings calls to better understand the fundamentals and future prospects of companies you follow
- Use trading indicators and tools to exploit short-term volatility
- Know how to protect your positions from this volatility
- Think about companies you might want to invest in over the long-term
- Set trading alerts
- Pick appropriate investment products to reach your goals (CFD, options, futures…)
- Always follow your earnings season’s trading plan
