Why I Don’t Play The “Earnings Game” — And Still Make Winning Trades
I’ve written about the earnings game before. In broad terms, this game takes place each financial quarter. And just like any good game, there’s a first half and a second half.
In the first half of the game, analysts speak to management teams to come up with estimates for the quarter. Throughout the half, analysts revise their earnings forecasts. Generally, the analysts revise estimates downward after these discussions.
In sports terms, if we think of this as a hurdle race, they would be lowering the bar. At the beginning of the game, the bar is about waist high. But by the end of the first half, the bar is just above the ankles.
Remember this part, because I’m going to come back to it in a second.
In the second half of the earnings game, companies report earnings. Many of them beat expectations — on average about 74% of those reporting in a quarter.
You may be rolling your eyes. Of course so many companies end up “beating” expectations. Company management just spent the first half of the game lowering the bar they’d have to clear. And when the company inevitably clears that low hurdle, its stock price jumps on the “surprise” news.
Now, I know some of you are skeptical that companies actually play this game. I’ve received more than a few comments that I’m just being cynical and that this couldn’t possibly happen.
“Amber, it’s against the rules.”
And in fact, that’s correct. It IS against the rules. It always has been against the rules. But it happens anyway.
The rule in question is Regulation FD, which says that publicly traded companies cannot selectively disclose material nonpublic information to some analysts or investors without disclosing it publicly. Basically, it’s the grown-up version of that essential elementary school rule that you can’t bring a special treat for only a few friends… you have to share with everyone in the class.
You can’t disclose nonpublic information to just one or two analysts. You have to share it with everyone.
Caught Breaking The Rules…
AT&T learned in March 2016 that a steeper-than-expected decline in its first quarter smartphone sales would cause AT&T’s revenue to fall short of analysts’ estimates for the quarter.
The complaint alleges that to avoid falling short of the consensus revenue estimate for the third consecutive quarter, AT&T Investor Relations executives Christopher Womack, Michael Black, and Kent Evans made private, one-on-one phone calls to analysts at approximately 20 separate firms.
On these calls, the AT&T executives allegedly disclosed AT&T’s internal smartphone sales data and the impact of that data on internal revenue metrics, despite the fact that internal documents specifically informed Investor Relations personnel that AT&T’s revenue and sales of smartphones were types of information generally considered “material” to AT&T investors, and therefore prohibited from selective disclosure under Regulation FD.
The complaint further alleges that as a result of what they were told on these calls, the analysts substantially reduced their revenue forecasts, leading to the overall consensus revenue estimate falling to just below the level that AT&T ultimately reported to the public on April 26, 2016.
As the chart below shows, the strategy worked.
This is just one example, but it demonstrates that the earnings game is played. (And that I’m not just being cynical.)
It also demonstrates one of the reasons why I will continue to avoid trading stocks of companies that are about to report earnings. There’s too much going on behind closed doors to get an accurate read.
How I’m Trading Right Now
If we leave a little bit on the table with some potential trades, that’s fine. Because there are still plenty of opportunities for us to make successful trades in any market, thanks to the proven strategy we use over at Income Trader.
Case in point, I recently made a trade recommendation in Automatic Data Processing, Inc. (Nasdaq: ADP).
The company announced earnings at the end of January and easily beat expectations. Whether or not it cleared that hurdle by playing the earnings game doesn’t matter to us. What does matter is that the positive earnings news sparked a rally in shares and triggered an Income Trader Volatility (ITV) “buy” signal.
ADP is now a short-term “buy.” Longer term, there are reasons to be concerned about the stock’s valuation, but there are reasons to expect a rally in the short run. The pattern on the chart suggests a price target of $197.
If the breakout fails, there is extensive support near $170. That means we can use my strategy to generate immediate income from ADP with a high probability of success.
We can make trades like this thanks to the ITV indicator. This is the award-winning indicator I developed years ago to identify high-probability trades. It’s a volatility indicator, which means it works similar to the VIX — a broad-market volatility indicator. This has led us to make winning trades more than 90% of the time over at Income Trader.
My strategy is simple and easy enough for anyone to learn. In fact, once you’re up to speed, it’s like getting a unique “PIN code” to generate an immediate payout each week. To learn more about my strategy, go here now.