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How to Trade on Quarterly Results

Friday 17 August 2012

By Dipen Shah, Kotak Securities

Every 3 months, companies, big and small, announce how they have fared in their business. So how does that impact you, the investor?We demystify the concept

What are Quarterly Results: Companies that are listed on stock exchangeare required to report the amount of profits and revenues generated over a period of time to a regulatory authority. In India it is SEBI, in the US, it is the Securities and Exchange Commission, and in the UK, it is the Financial Services Authority. Typically, an earnings announcement is unveiled on a quarterly basis and represents activity in the previous three months.

A quarterly earnings statement is a report card of a corporation's financialperformance during the quarter.Quarterly or annual balance sheets reveal how healthy a company is compared to the previously reported numbers.

Often, shares in a company will trade in heavy volume in response to the earnings results. This means that many investors will either buy or sell shares based on what the earnings announcement reveals.For instance, financial analysts set an expectation for what the earnings results will be. If the company meets or exceeds those estimates, the stock price will rise. If estimates are missed and earnings are worse than anticipated, market participants often will punish that stock by selling shares and subsequently putting pressure on the value of that stock.

The Importance of Quarterly results: Every quarter, companies announce their profits and earnings, other important information and, in some cases, their guidance for what they expect the next quarter's activity to be like. Companies are mandated by law to announce these results within 45 days of the quarter end. This period is known as 'earnings season'.Quarterly earnings are necessary as they give early signals of the happenings in a company. Investors get information about the company's performance during a quarter, rather than having to wait till the year-end. Necessary action can be taken by the investor based on these results. What most people focus on in these reports is the earnings per share number, which divides the earnings or profits of the company by the number of shares outstanding. This number is commonly described as EPS.

What is trading on quarterly results? Trading by quarterly results is when you are betting on a stock to go up or down right after the company reports its quarterly earnings. If you believe that any company will produce better results than the general market expectation, then there is high probability that the stock price will rise once the results are announced. Taking appropriate action can help you in making quick returns.

Is trading on quarterly results the right approach for you? First of all, trading earnings results is a high risk, high reward style of trading. If you are a beginner or if you cannotsee the price of your stock going down sharply on a single day, then you should not trade on earnings results. That is because sometimes, a stock can drop more than 10% when a company's earning is contrary to your expectation and below market expectations.

That is not to say trading earnings is not profitable. If you do it correctly, you can make money in a few days. A stock can go up over 10% in a single day when the company reports good earnings or earnings that beats market expectations.

How Can You Trade Ahead of Earnings result? You can trade ahead of earnings results, by buying shares in advance when you expect a company to announce better-than-expected results.

Though that can be a profitable strategy,remember that if the stock price moves against your position, sell out and manage your risk. These usually aren't investment plays, only short-term trading plays that may last a day or so, so don't let a trade that went bad turn into an investment. And remember that these earnings trades are speculative and risky in nature so always be ready to revise your positions.

High probability trading on quarterly results: Here are a few strategies that participants can use to make a high probability trade using earnings results. Let's say if you are going to trade a particular stock, below is some research that you must do before trading.

1. General Stock Market - Is the general market good? Are other companies reporting good earnings? If the answer is no then you should be more cautious and likely stay away from trading the earnings results. In a bad market, even good results may lead to a fall in stock price.

2. Stocks within the same sectors - Are other stocks in the same sector reporting good earnings? In the case of IT stocks, you will want to check how the whole IT sector is doing. There are companies that this company does business with or competitors that report earnings prior to the target company. If they are doing well, chances are that the target company will also do well.

3. How the stock is doing - You need to do research on the company itself and on the stock movement. Is the company beating earnings estimate over the past quarters or is it falling short? Is the company doing well relatively to the other companies in the sector? If yes, the probability of the company repeating the performance is relatively higher.

4. Stock Charts - You need to study the general trend of the stock. Is it in an uptrend? Is the chart bullish? If the chart is bullish, there is a good chance that it will continue.

Happy Trading :)

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