Symantec: A textbook example of the value of earnings guidance

Earnings season is a quarterly event that is much anticipated by traders. The reason is that earnings reports themselves can be newsworthy events and it’s newsworthy events that creates and reinforces the perceptions of the investing and trading community which in turn leads to trading action. If a sector giant (such as Intel, Exxon/Mobil, GE, Amgen, etc.) posts better than expected numbers, this not only bodes well for that particular stock but also for its sector. If the sector is influential in the pricing of certain market indexes, then a rise in one key stock can raise the overall market. This is why traders especially love earnings season because it gives them something to play with for a couple of days at least. Investors look at the full earnings report for longer-term investment indications.

So, if one’s a trader, what is the best way to play earnings and what are some of the key ingredients that make a stock pop or drop? To address these issues, I’ll be using the chart of data storage and software security company Symantec (SYMC) because it’s chart is a graphic illustration of the effects of both good and bad earnings reports.

Earnings data for the past two years are summarized in the chart below.


Future guidance is the key to post-earnings stock price
What is most interesting is not whether the company beat analyst estimates, but whether its future outlook beat analyst estimates. “Buy the rumor and sell the news” could never be more true. For those who think they can predict whether or not the company will beat estimates, you can see from the above table that beating estimates has a secondary effect on post-earnings stock price. The primary effect, first and foremost, depends on how the company guides. Even in relatively down markets, a positive guidance can cause the stock to jump, if only temporarily.  (See 1/28/09 on the chart below.)


Earnings plays
Holding stock over earnings is a usually a suckers bet unless there’s nothing to lose. Sometimes a negative earnings report can pop the stock because it wasn’t as bad as Wall Street expected, but that’s not an easy call to make. Usually, most stocks go down after earnings and you don’t want to be the one left holding the bag.

Better to buy a stock with upwardly guided earnings and sell just before the earnings release. This works best if the market is in an upward trend but it can also work in sideways or downward markets depending on how much sizzle is associated with your stock. (Please note that once in a blue moon companies do report earlier than expected so I like selling a day or so in advance.)

Post-announcement plays are a good move, too. Companies that guide higher than Wall Street expectations can ride the wave upward typically for as long as the overall market holds up (barring any negative news on the company). On the flip side, lowered guidance combined with a bear market can be profitable for short positions, but short positions are riskier enterprises with shorter holding times.

I hope you’ve gotten a feel for how to make some profitable earnings plays. As always, paper-trade your strategy before committing real dough and check out the for further earnings recipes.

Disclosure:  No positions

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