With earnings season in full swing, this is a good screen to use both before and after a company reports.
Like any earnings season, we’re going to see both positive surprises and negative surprises.
This screen however focuses on more than just earnings surprises, but instead goes over the importance of both earnings surprises and sales surprises, and why as an investor you should care so much about them.
As you know, if a company reports earnings above expectations, that’s a positive surprise, and the price in general should go up.
If the company reports earnings below expectations, that’s a negative surprise, and the price in general should go down.
But a surprise is more than just a snapshot of an extra few dollars and cents a company made or lost in that one period. Instead, it’s a glimpse into what a company’s earnings could be, or should be, in the future.
And when these surprises occur, the market tries to quickly re-price that stock to reflect these changes.
Not All Surprises Are Created Equal
Some earnings surprises are due to revenue increases, and other earnings surprises are due to cost cutting measures.
Top line growth (or sales growth) usually produces the biggest price reaction over cost-cutting, because an increase in sales is generally thought of as more sustainable. Once you’ve cut costs, where’s the future growth going to come from? You can only cut costs so much. You need sales to drive long term growth.
There’s also guidance. What the company sees down the road is important.
If you’ve got a positive surprise on one hand, but then downward guidance on the other, that’ll usually produce a negative reaction. Why? Because they’ve taken away the hope generated from the surprise by saying the future outlook will likely be weaker than expected.
There’s also the idea that some surprises aren’t really surprises — either because a company has a history of continuously beating their estimates or the stock has already priced in a ‘surprise’ by running up or going down prior to the announcement; therefore, the ‘surprise’ in that direction really wasn’t a surprise at all. That’s where you’ll sometimes see an opposite reaction to an earnings surprise – a “buy the rumor sell the fact” type event.
But while predicting which companies will surprise or not can be difficult, the benefit of an earnings surprise will typically last for one to three months after a surprise is reported.
So you can get in after a company reports a surprise, or you can try and find companies that are more likely to report a surprise, and get in ahead of time.