Hazelle
in Memos & Musings · 4 min read
It is the period of earnings announcements again. Earnings season is the period of time when publicly traded companies release their quarterly earnings reports. Because they are publicly available to trade in, public companies are required to report their financial health in order for investors to make informed decisions. To some investors, the earnings season is perhaps one of the few things happening in the stock market that happens with some form of transparency because there are numbers that can be scrutinized which everyone has access to.
One of the common questions I get from my students is that can we develop some sort of strategy either before or after earnings are announced. It usually goes like that- shall we long the company if we believe that it will have good earnings or simply short it when it has poor earnings. (long means to be bullish while short means to be bearish)
If only investing was that simple.
If you have invested long enough, you would see that a stock price can fall even if it blows past expectations or vice versa. The stock price may not exactly follow the financial results. To make things worse, during earnings season, the stock market is especially volatile. Not just for the stocks that are reporting their earnings, but also those that are in the similar sectors or industries. Oftentimes, they will move together in tandem should their prices rise or fall. What this means is that even if you know the results beforehand you may still not be able to predict the direction of the movement. And after the results are announced it is also too late to go into either direction. Just because a good company has one of the worst quarters now, usually means that it is going to rebound pretty soon and it wouldn’t be wise to bet against it.
So then as investors what can we do?
One of the several strategies we use is to study the fundamentals of the companies that we invest in. And we examine their performance over a long period of time of at least 5 years and beyond. (By way of elimination, yes it means that we don’t invest in IPOs) We want to see some level of consistency at the point of purchase. Once the groundwork has been done, we are not perturbed by the short term earning results which can go either way.
For those that have been following us, you would know that we are a fan of U.S. growth stocks, in particular the technology sector. We have Amazon shares that blew past expectations. We also held Facebook that experienced a historical crash. It was a mixed bag of results. Were we ecstatic by what happened to Amazon or disappointed by what happened with Facebook?
The short answer is no. Just because you may have constructed a portfolio of good stocks that are poised to do well in the long run, it does not mean that these companies are going to have a blow out quarterly performance again and again. Businesses have their fair share of ups and downs. And if they were doing particularly well last quarter, often it won’t be long when reversion to the mean comes in. Businesses may also undertake research and development projects that do not contribute to the top line while incurring significant costs, which is a necessary step in order to open up future demands for their new ventures.
In the short run, similarly to the game of Poker, the results of one or two hands in the game doesn’t really matter. It does not necessarily mean that I am a good player just because I have a string of wins or a bad one with a few losing streaks. Instead, focus on the cumulative profits or losses that stack up over a long period. See how much you win when you win, and you lose when you lose.
In the short term, the role of luck does come in too. While majority of the time good companies tend to beat earnings, occasionally they fail to. But over a longer timeframe, it is the skills of analyzing companies or market sentiments that will matter more and give us the winning edge.
Do not let a few trades result in you being overconfident or to be totally crushed. It is the compounding over the long term that will matter for wealth creation.
About Hazelle
Chief trainer of The Moneyball Investors Playbook program and founder of The Joyful Investors, a financial education firm that seeks to help avid investors learn to invest better and make the journey a joyful one. I graduated with a first class honors in Bachelor of Accountancy from Nanyang Technological University (NTU) and started my auditing career in one of the Big Four. I believe that once we know how to build our wealth sustainably, we can then live our best lives ever.
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