The secret to profiting from earnings reports: Buy high, sell higher

Highlights in this issue:

*** Earnings season has begun – use it to profit…
*** Don’t make the crucial mistake of jumping in too fast…
*** The only number that'll really tell you which way a share's heading… and more…

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From the pen of Karin Iten

Dear Investment Academy Reader,

It’s earnings season in the US and the markets are abuzz with investor hype. Why are they so excited? Well, if company earnings (even really bad ones) come in better than the market expected them too, then that company’s share price usually runs up – fast.

To explain exactly how you can use this time to cash in some big gains, I asked Matthew Weinschenk – a senior analyst at our sister publication in the US, Investment U – to give you his top secret tip…

Over to you Matthew…

The #1 reason why I love earnings season

Whenever corporate earnings season rolls around, many investors would love to play the various announcements and profit from them.

Trouble is, they don’t know how to without exposing themselves to the volatility and risk that goes with earnings season. You see… they think about earnings reports the wrong way – and leave cash on the table because of it.

Let me explain…

Conquering the earnings minefield

Let’s say ABC Publishing is set to report its quarterly earnings in a week’s time. So how can you make money from it?

To predict earnings, we can breakdown all the financial reports, study web traffic and retail numbers, project revenues and costs, and arrive at an earnings number. But chances are we’ll be totally wrong.

That entire method is fundamentally flawed. Individual investors can’t put this much time into a single share and being off by just a cent means you could lose a bundle, since earnings estimates (no matter how arbitrary) are a crucial part of the process.

So what do you do? You watch and wait.

How you can claim post-earnings profits

Now, if the company surprises investors by earning more than expected, its share will shoot up.

However, you can still make handsome profits by buying after everyone knows about earnings – even though the share’s already up.

Here’s why: After an earnings announcement, shares don’t fully “price-in” the new information immediately. Instead, it makes an initial move, but it’ll then drift in a predictable direction for the next three to nine months.

This isn’t the stock market version of an old wives’ tale. Academic researchers call this the “post-earnings announcement drift” and have verified it statistically, time after time, for the past 40 years.

So the debate is no longer whether it exists… but why.

Post-earnings announcement drift baffles researchers. They see profitable opportunities as simple and reliable as these simply shouldn’t exist in a so-called “efficient” market.

Fortunately, they do.

A dozen ways to identify an earnings cash cow

You should watch for earnings surprises as a powerful first screen for finding promising shares. Or, if you were considering buying a particular share that just disappointed the market, think twice. You’ll be fighting a strong tide that wants to pull it downwards.

The important thing to remember is not to give up on a share that just jumped in price thanks to higher earnings. The best is often yet to come.

And remember, share prices follow earnings. They dictate which direction the share will go in. Don’t ignore this vital number.

Till next time…

Here’s hoping you spot that double-digit winner,

Matthew Weinschenk
for The Investment Academy