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Four times throughout the year, most financial TV channels and publications focus on reporting earnings from America’s largest companies. These quarterly updates from publicly traded companies can significantly impact the market, its volatility and price direction.
In this article, we’ll break down what corporate earnings announcements are, why they matter, and how beginner traders and investors can navigate them.
This material is for informational purposes only and not financial advice. Consult a financial advisor before making investment decisions.
What Are Corporate Earnings Announcements?
Publicly traded companies in the U.S. are required by the Securities and Exchange Commission (SEC) to report their financial results every quarter. These earnings announcements typically include:
- Revenue (sales)
- Net income (profit)
- Earnings per share (EPS)
- Guidance (projections for future performance)
These reports are released in quarterly filings, using the Form 10-Q, and are often accompanied by a press release, a conference call with analysts, and investor presentations. The earnings data is closely watched by analysts, institutional investors, and retail traders alike.
Why Earnings Matter
An earnings report offers a snapshot of a company’s financial health and is, therefore, a crucial factor in determining its value and future stock price direction.
Generally, when a company posts results that beat what analysts were expecting, the stock price may rise. Conversely, if the results miss analyst estimates, it could lead to a sell-off.
In reality, no one can predict how a stock’s price will react to an earnings release, as there are many other nuances to take into consideration. This includes other news the company might have (a new acquisition, or product release), as well as what is already priced in.
There are three main components of an earnings announcement that traders, investors and analysts tend to focus on:
- Actual Results vs. Expectations: Most of the media attention goes to how the company has performed relative to analyst estimates.
- Forward Guidance: What the company says about its future performance can matter more than what happened in the last quarter.
- Management Commentary: The tone, insight and rationale for executive decisions from the management team during the earnings call can influence investor sentiment.
The Earnings Calendar: When Do Reports Happen?
The U.S. earnings season happens four times a year, shortly after the end of each fiscal quarter:
- Q1 earnings: April – May
- Q2 earnings: July – August
- Q3 earnings: October – November
- Q4 earnings: January – February
During the earnings season, companies release their performance metrics for the prior quarter. However, as some companies have different fiscal accounting periods, the quarterly name and year can differ.
How Stocks React to Earnings
Earnings announcements can lead to sharp and sudden price movements. This happens for many reasons, a few are highlighted below:
- The market is forward-looking and prices in expectations, so traders will readjust positions accordingly.
- Surprises (positive or negative) lead to a fast readjustment of positions and rapid repricing of a stock.
- Trading volumes often spike due to increased interest and volatility.
For example, if a company was expected to report $1.00 in EPS (earnings per share) but the figure comes in at $1.25, that surprise can boost investor confidence and lead to a rally. However, this effect can be negated if they also release a forward guidance that is lower than expectations.
Conversely, even if the company posts record profits, if it falls short of Wall Street’s expectations, the stock price may fall. Therefore, analysing the whole earnings report is essential before making any decisions.
What to Look for in an Earnings Report
Here are some things to look for when analysing earnings.
A stock may struggle if there is:
- Declining revenue or profit margins
- Lowered guidance
- Rising debt levels
- Weak commentary from management
- Multiple quarters in a row of missed earnings
A stock may find some support if it:
- Beats both revenue and earnings per share estimates
- Raises forward guidance
- Expands profit margins
- Posts strong cash flow and balance sheet
- Provides a positive commentary on growth areas
Can You Trade an Earnings Report?
It’s important to understand that trading around an earnings report is notoriously difficult and carries significant risks.
First of all, there is a lot of information to analyse in a short period of time. Institutional traders have dozens, if not hundreds of analysts around the world, analysing the same information. It is very difficult to try and compete at this level.
Secondly, if there is a big surprise in an earnings report and it is released while the market is closed, then the market can gap on the open. This means the stock price could gap beyond your stop loss price level, resulting in a larger-than-expected loss.
A more conservative approach may be to wait and see how the rest of the market reacts to the earnings report and then trade any clearer price action after the event.
Conclusion
While earnings season can be intimidating to try and trade on, it also represents a good opportunity to learn how a company operates and what the market thinks of it. If trading around earnings, it is important to risk manage effectively to deal with the unpredictable volatility and potential for market gaps on the open.
It may be more prudent to simply wait until after the dust settles and make your decisions with a clearer view on the market’s response and price action. You can also practice trading a demo account to test any theories and strategies in a virtual environment.
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