Make no mistake about it… earnings season is in full swing, with more than 1,000 companies reporting this week.
For some traders, earnings season is the most profitable part of the year…
Because it’s usually when stocks experience their greatest volatility. And for active traders, the more volatility in the market… the more opportunities there are to turn in quick profits.
Not only that… there are a number of trades that one can take before, during, and after an earnings event.
However, if you’re unsure of what to look for, and where the drivers are… then you could be missing out on some of the biggest profits of the year.
That said, I’ve put together a case study for you, which highlights Amazon’s recent earnings.
After you go over it, you’ll know the key terms that traders watch for in an earnings release, as well as, what causes some stocks to have massive price swings after they release.
Well, it’s that time of year… earnings season. It happens four times a year… and these are the times when companies update investors on their quarterly progress, as well as provide projections.
With that said, there’s a lot of volatility around earnings… and it gives us opportunities to day trade, as well as swing trade.
Now, traders have different views on earnings… some think it’s a bad idea to trade them because there’s so much uncertainty… while others love trading earnings for the very same reasons.
Whichever camp you’re in… it’s important to get familiar with some key terms, which I use in one of my latest strategies to consistently find winners.
Earnings Per Share (EPS) and Revenue
Now, EPS is defined as the portion of a company’s profit allocated to each outstanding share of common stock.
On the other hand, revenue is simply the amount of money that a company receives during a specified period. It includes discounts and deductions for returned merchandise, goods, or services.
You can calculate revenue by multiplying the price of which goods or services are sold with the number of units sold.
Luckily for us, that’s all done for us and we just have to look at financial statements or headline numbers for that.
One thing you must keep in the front of your mind: everything is relative. An earnings release can be good, bad, or in-line. However, what determines that is expectations. If a company “surprises” during its earnings release, expect to see crazy volatility in its stock price.
For example, here’s a look at the quarterly earnings history for Amazon.com (AMZN):
Now, these earning results are filed with the SEC, in the form of a 10-Q report, for quarterly results, and 10-K for annual results.
They include a company’s financial statements, how the company is making money, it’s costs, expenses, future challenges, and future outlook (if the company provides guidance).
Key Metrics to Focus On
Two key figures that traders watch in these filings are EPS and Revenue. They can be used as indicators to show the quality of a company’s performance for a given period.
Basically, gross Revenue tells us how successful a company is at attracting customers or promoting services.
On the other hand, EPS tells us how effective the company is in managing its operations: what margins are like, its ability to generate adequate cash flow to service debt, pay dividends and increase value for shareholders.
Now, an earnings surprise can have a tremendous impact on the underlying stock price.
Heck, some institutions will use sophisticated machine reading algorithms to take advantage of an earnings announcement right as it is being made.
They more or less react to keywords. That said, there can be a lot of volatility, especially if they are wrong, the stock can quickly reverse from positive to negative in a blink of an eye.
You see, EPS and revenues are not the only things traders care about. They are also interested in what the company has to say about its outlook for the future, which in the industry, the phrase used is “guidance.” But not every publicly traded company issues guidance.
Of course, analysts and market participants prefer companies that issue guidance, the more information, the better.
Guidance Moves Stocks
For example, last week Amazon reported its 2Q 2019 earnings results. On the headline numbers, AMZN actually did worse than analysts expected.
AMZN reported EPS of $5.22 vs. $5.57 consensus estimate (according to analysts surveyed by Refinitiv).
That means AMZN missed on the bottom line.
However, the company reported $63.4B vs. the $62.5B consensus estimate. In other words, AMZN beat on the top line. However, traders brushed those numbers off because they were mixed.
So what did they focus on?
Guidance and EPS.
Amazon missed on its estimates and surprised by over 10%, based on some consensus estimates. Not only that, AMZN guided net sales between $66B to $70B for the third quarter of 2019.
However, its operating income is expected to fall by 43% year over year… and that impacts the EPS growth, as analysts were looking for 15.5% growth in the third quarter.
Here’s a look at what AMZN did after its earnings announcement.
As you can see, even if you’re not trading earnings… it makes sense to understand these metrics because they could be helpful if you want to trade the stock a few days or weeks after the announcement.
Now, one thing to take note of is the fact that sometimes a company will announce EPS and revenues…
…but you might have to hop onto the conference call to get the guidance.
The conference call is free to attend and consists of analysts and investors, who ask questions to the company directors about its numbers and outlook.
This is an opportunity for management to potentially spin what appears to be a bad number into something more optimistic. On the other hand, if the management sounds negative, or is unable to answer the tough questions, it might be reflected in the company’s stock price, as traders are reacting in real-time to the conference call.
Additionally, some companies won’t even provide guidance, so the only numbers traders will look at are the EPS and revenue figures.
There are three main components to an earnings release: EPS, revenues, and guidance. However, each individual company is different. A company can beat on EPS and revenues, but see its stock price drop, if guidance is weak.
In addition, companies have a chance at redemption with the conference call. It’s an opportunity for management to get in front and address any issue that the Street might have.
Now, after an earnings release, investment research firms will update its price targets and ratings on a stock. As a fun game, compare your notes with the analyst’s and see what you both come up with.
This is a just a “get your feet wet” introduction. Earnings releases can get more complex, especially when a company releases earnings using different accounting methods. But we’ll have to save that discussion for another time.
Now, if you’re interested in using earnings releases to your advantage… then you’ll want to check out my newest trading system, Sniper Report.
Here’s how it’s helped so many traders already…