How earnings affect stock prices

5 Ways Earning Affect Stock Prices

By Matt Billings, SVP of Trading Services 

Earnings season is a busy time in the markets because of how earnings results impact stock prices. Analysts, investors and traders all look for bits of information that might assist them in making informed decisions about the companies they follow. While data can always be interpreted differently, here are some things to keep in mind during earnings season.  This isn't meant to be a comprehensive list, but a starting point.  

1. Earnings and Growth Estimates Could Drive Prices

Many valuation models are driven by expectations surrounding earnings, rates of return, interest rates and cash flows.  With so much focus on forecasting, part of a company’s estimated value is driven off of things that haven’t happened yet. It’s a good idea to try and decide for yourself if you think the estimates are reasonable or overly optimistic. This in part is why a company can report good results but still see a drop in their share price (or report poor results but still see an increase in share price). If the market expected great news but only got good news, you shouldn’t be surprised to see subsequent price movement.

2. Small Changes in Estimates Can Have Large Impacts on Prices

Earnings estimates are a sensitive indicator so the slightest deviation from expectations can have an out-sized impact.  Many pricing models use a number of forecasts, so even minor changes can cause price dislocation. In some models, individual variables can be weighted to have smaller or larger impacts than other variables. This means a change in one variable could have a substantial impact on the predicted value of the underlying stock.    

3. The Headline Numbers

When analyzing the earnings reports yourself, look at operating results from the core business.  It is possible that the headline earnings number was helped (or hurt) by other income sources that are not directly related to the core business. There are also one-time items that will impact earnings in the short-term but not necessarily long-term. 

4. Earnings and Guidance Can Act as a Leading Indicator

Most publicly traded companies have competitors within their industry. By following the competitors of companies you’re watching, you might pick up on challenges that are affecting the entire industry. Additionally, some companies are so large that their reported results can give clues as to the current status of the U.S. and global economy. 

5. The Spin

Earnings conference calls start off in a scripted manner, and management teams have it in their best interest to frame things in a positive light. 

It helps to avoid getting caught up in the tone of the conversation on the earnings call.  Be critical of earnings numbers that come with little guidance or clarity.  At the end of the day, the numbers are what tell the story.  It is then up to you to decide how and if to act. Analysts and investors are able to make more informed decisions about the future of the company when they look at the big picture without buying into “the spin.”

Buy-and-Hold Investor Consideration

You’ll hear the advice to focus on the long-term; one quarter’s results aren’t necessarily significant. While you do want to stay focused on the long-term, significant events can happen in the short-run that have long-term implications. You’ll want to be aware of those changes to examine how deep the impact goes and what result they could have on the profitability of the core business.

Active Trader Consideration

Monitor the market action and know how it fits into your trading plan. Define entry and exit points that fit your risk/reward profile. Avoid forcing a trade because you feel like you’re missing the opportunity. New opportunities become available every day, so remain patient and wait for the opportunity that fits your overall strategy. 

Read Next: Earnings Reports that Matter

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