Understanding Earnings Reports
Hello, traders. Welcome to the Stock Trading course and the fourth module short to medium stock trading. In this lesson, I’m going to teach you how to read an earnings report. But we are going to start by defining what an earnings report really is.
So what is an earnings report? An earnings report is a quarterly filling made by public companies to their…to report their performance. Including in earnings report is the net income, the earnings per share, the earnings from continuing operations, and the net sales. And the most often key metrics are earnings per share and net income. This is what we are going to use to know if a company has done better or worse than the previous quarter and on a year-over-year basis. The earnings per share is the portion of the company’s profit allocated to each outstanding share and you calculate it by adjusting the net income from dividends and dividing it by the average outstanding shares. And the net income is a company’s total profit minus its expenses. So these two metrics are usually compared to the previous year’s numbers but the main comparative we are going to be using is the analyst’s expectations from these two metrics.
If a company surpasses analyst’s expectations and earnings per share and net income, it has beaten expectations and the stock will have a very bullish pressure. On the contrary, if a company’s EPS and the net income is worse than the analyst expectation, it has misexpectations and the stock will most likely sell off. And this is basically how we are going to be reading the earnings report of a company. We are going to focus on the earnings per share and the net income release and we are going to compare it to the forecast or consensus by the analyst.
Now, how do we trade earnings report? First of all, during earnings report of market will get very volatile because most of the times, companies report earnings before the market opens or after it closes. And the reason for the volatility is that the volume is very thin pre and post-market, okay? There’s not a lot of people who trade the pre-market. They usually wait for the market to open and these people also don’t trade the post-market because of how thin it gets and because of how thin the book is, it can get very volatile and one big order can actually move prices in the stock very aggressively. When earnings are released before the opening bell, it’s easier to trade them. And why is that? Well, it’s simple. If a company misses expectations, you sell the opening and you put a stop-loss above the previous high. But if it beats expectations, you buy the opening and you put a stop-loss below the previous low. If a company reports after the market closes, you have to wait for the next day of trading to follow the move on a retracement. For example, if a company reports after the close of the market and it beats expectations, the price of the stock will go up immediately in the post-market. But you are going to wait until the next day of trading to buy that stock on a retracement.
We don’t recommend trading when markets are thin and extremely volatile. And the reason is that, well, if you’re not used to trading in extremely volatile environments, you are going to have a hard time getting filled. Sometimes, your stocks are not going to get filled. You have to be very quickly with your orders to close your trades, et cetera. And of course, sometimes, it can be very psychologically hard because you might be up in the trade and seconds later, you might be down on it. So, we recommend for you to wait until the market opens if the company reports before the opening bell or the next day if it reports at the close. Remember that the company must beat or miss both income and EPS for you to be able to buy or sell at the open and the reason is that mix earnings report can be much trickier to trade and well now we are going to…well, I’m going to show you how to know which companies are going to be releasing their earnings on a daily basis and that’s simple. You would just go to Google and type “earnings report calendar” and you’re going to have multiple choices and I recommend well, the CNBC earnings calendar is quite nice so let me show you how it looks like.
And here it is, the CNBC earnings calendar. And as you can see, we are Wednesday 14th October, 2015 and today we got 14 expected announcements. For example, we have Bank of America, we have Delta Airlines which already reported and as well as Bank of America and I think we have JP Morgan and [inaudible 00:06:11]. As you can see here, Bank of America profit beats. So we have a beat on Bank of America and well, let’s go and see and take a look at our chart of this stock to see how it reacted.
Okay, here you go. This is the Bank of America chart and as you can see, by this big move to the upside, we have a very bullish reaction to the earnings which was a beat. We were expecting or the expectations where a 0.34 EPS and we beat it by 3 cents which made all the bulls come into the market and as you can see, this is the pre-market and the volume is very thin so we are going to wait for the market to open to be able to trade, well, to trade this earnings report. Now, I’m going to show you a stock that had a…well a company that had its report last Friday, which was a miss. And I am going to show you how the trade worked.
First of all, we’re going to go to the [inaudible 00:07:34] economic calendar. And as you see, I only have checked the earnings here and I’m going to show you. No, it was on Monday, actually Monday October 12, SXC which, well, SXC had an estimated EPS of 0.025 and the actual EPS was minus 36 cents which was a huge miss. So let’s go to the chart and I’m going to show what this looked like.
All right. Here we go. You can see that here we have the earnings widget on the chart and well let me show you. We have an estimated earnings per share was 0.025 and the actual is minus 36 cents which was a huge miss. This was pre-market action so you can see that when it opened, it flushed from the 961 level to 714 level which was a huge move for a $10 stock. Now, just take a look at…let me put on some price levels here. We have this price level. All right. Around here which is the previous high on Friday’s action, okay, which was at 985 and if you were able to, hold on. Yes, if you were able to sell the open, this will mean that you would have had a, well, you would have short-sold this stock if it was available to short stock, of course, at around the 960 level which means that you would have had a stop of only 23 to 24 cents.
Now, let me zoom in on this price action chart. And as you can see, well it opened with a gap and it completely flushed until we hit the daily lows at around 694. Of course, it’s really hard to hold onto a trade for the entire ride but I mean if you were just moving your stocks to a previous high, you would have been taken out around here at the 733 level giving you more than $3 profit per share shorting. And this is basically how we’re going to be trading earnings report and remember, it gets pretty volatile and in this…well, in these kinds of stock that are pretty thin because just look at the volume, at the average volume the day before it was around 8,500 shares and then the average volume here was around 60,000 shares. So, because this is only just an earnings play, we are just going to short the opening and then we are going to move on from this stock.