Alcoa unofficially kicked off earnings season on Monday and traded flat for most of Tuesday after a mixed quarter. Now, we prepare for a volatile six weeks, as most of the S&P 500 will report their quarterly reports during this period.
While you may hold a stock that will rally 15% after reporting earnings, there will be many who are prepared to chase gains, buy before earnings, and will overreact to initial top and bottom line numbers. In this piece, with earnings season expected to be particularly unpredictable, I am giving you four rules to follow.
Rule #1 Read & Listen!
This might sound like common sense, but far too often retail investors get trapped with the initial volatility following earnings. But here’s the thing, sometimes the market will get it wrong, which will create value–or a value trap.
Therefore, the first and most important rule is to actually take the time to read the quarterly report. Then, after your initial impressions, listen to the conference call and the Q&A with analysts. This conference call will be very important, as the Q&A will be the basis for future upgrades and or downgrades.
Rule #2 Be Patient
If you follow Rule #1 then chances are you will be patient. Because after all, a stock may trade for hours before the conference call is complete.
There are countless good examples of why this is important; most recently you can look at Hi-Tech Pharmacal Co. (NASDAQ:HITK). The healthcare company announced Q4 earnings before the market opened on Tuesday, missed on both the top and bottom line, and traded lower by 7.3% in the premarket.
However, its conference call began at 10:00 am ET, and its stock slowly begun to creep higher from $31.50 to over $35.00. The reason was because of the upbeat tone on the call, and the outlook that prices for its Fluticasone Propionate nasal spray product may be stabilizing. Also, additional details of a $15.5 million settlement that negatively affected its earnings were discussed.
The moral of the story: Use earnings to your advantage to capitalize on the initial, and often illogical, behavior. More times than not, the first 30 minutes of trade do not carry throughout the day.
Rule # 3 Seek “HOGs”
In my book Taking Charge With Value Investing (McGraw-Hill, 2013), as I lay out 20 rules for earnings, I discuss what I call “The HOG Effect”.
The HOG effect refers to an investment I made in Harley-Davidson, Inc. (NYSE:HOG) back in 2011. Harley-Davidson, Inc. (NYSE:HOG) announced earnings in October 2011 and traded lower by 7%, despite beating expectations.