I am currently a new trader and I’m playing the Sharemarket Game and over the weeks I closely analyzed all the companies. To my complete surprise one of the companies (Downer EDI) went from -0.81% on the 20 Feb to 14.29% on the 21 Feb and there were no announcements prior to this. The day the price sky rocketed was the same day they announced their half-yearly profit. Please explain how I can in future pick stocks like these and what are the indications?
Reporting seasons are the most important times of year for the share market in terms of analysing company performances. Twice a year it gives analysts and investors detailed insights into how companies are performing both individually and compared to their peers. The overall results during reporting season can lead to positive or negative market sentiment that will continue into the months ahead.
During the reporting season, it is not uncommon to see large share price movements when companies report. However, it is not the actual earnings figures that lead to large share price movements, but it is the difference between the expected results and the actual results that will make share prices move. This difference is typically known as an earnings “surprise” because it was unexpected.
Share prices will reflect current expectations. If expectations differ significantly from actual results (ie: there is a large surprise) then the share price will adjust accordingly. For example if a company reported a 20% increase in profits, this looks good at first glance, but if it was widely expected to announce an increase of 30%, the share price would probably fall significantly.
What has become more of a factor this year as profit growth has slowed is not just earnings results, but future earnings guidance. You can see stocks such as JB Hi-Fi which announced profits higher than consensus estimates, but also forecast slower sales growth than previously expected. This resulted in the share price falling heavily that day, despite announcing earnings above what was expected.
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One of the reasons why the Downer EDI share price jumped is that its profit figures came in slightly above expectations (this was a surprise on the upside) but also because it reaffirmed its future earnings guidance which pleased the market and was not fully reflected in the share price prior to the announcement. In the two years prior to these results shareholders had been hit with multiple earnings downgrades, so to reaffirm a positive outlook was very welcome news to long suffering investors.
It is a popular strategy by traders to try and predict whether earnings announcements will be better or worse than expected and take positions in stocks in the days before the announcement. This is quite often done by using derivative products such as CFDs as they offer greater leverage to share price movements.
One indication is past performance. There is a belief that good news often follows good news, and bad news often follows previous bad news. Therefore some traders will take a position in a stock which has recently beaten profit expectations in the hope they will do it again. This has been the case with CSL recently. It’s last three profit announcements have been better than expected and have seen the price rise significantly on each of these days.
Along the same lines, companies who have recently upgraded earnings forecasts also often beat profit expectations. This was true recently with Telstra and Qantas who both upgraded profit forecasts in the months before their results and then released results above expectations. The share prices of both these company’s opened higher the day of their results announcements.
Another indicator can be looking at companies operating in the same industry. A recent example of this can be seen with JB Hi-Fi and Harvey Norman. First JB Hi-Fi was sold down heavily on the day of its profit announcement and then just over two weeks later the Harvey Norman share price fell sharply after its profit announcement. Both companies reported strong earnings but the both were sold down due to higher interest rates expected to cut into discretionary consumer spending in the future.
Another indicator can be looking at companies operating in the same industry. A recent example of this can be seen with JB Hi-Fi and Harvey Norman. First JB Hi-Fi was sold down heavily on the day of its profit announcement and then just over two weeks later the Harvey Norman share price fell sharply after its profit announcement. Both companies reported strong earnings but the both were sold down due to higher interest rates expected to cut into discretionary consumer spending in the future.
Matthew Chambers, Dealer, IG Markets
