Earnings season really brings out the investors with short attention spans and even shorter memories. During these fascinating few weeks every quarter you can find headlines like: “Amazon Plunges After Earnings Miss/Beat Because They Suck” (this was an actual article on Jim Cramer’s website thestreet.com). Analysts criticize corporations for earning a few pennies less than what their spreadsheets predicted, and short-term traders jump in and out of stocks they’ll never trade again.
This is a time for extreme market reactions to the upside and downside. Even the most extreme moves have a basis in logic: an earnings miss here, some lowered guidance there. The magnitude of these moves, however, is hard to justify. Short of bankruptcy or fraud, it’s hard to argue that a company is suddenly worth 30% or 50% less than it was just a few hours earlier.
Economists have argued that this is simply the market’s way of processing new information, but ample evidence suggests there’s more to the story. Some stock moves are exaggerated by momentum, while others are quickly corrected. Neither of these phenomena suggest a perfectly rational market. They suggest just the opposite.
So, how do we handle the ups and downs of earnings season?
Investing is one of the few pursuits where procrastination may actually help you. The key to good analysis is perspective and calm, which are tough to come by as stock prices are rapidly moving. It’s amazing how much a good night of sleep can change how an investor views results that seemed catastrophic just the day before. Moreover, there’s very little downside to waiting. Whenever I make a decision I make sure to be as deliberative as possible. Do the research, wait, do more research, wait, and so on. This gives me perspective that I wouldn’t get trying to respond to unfolding events. If a company falls today, it’s a coin flip on whether it will be up or down in a few days. In the time frame of days and months there are now predictable trends, sometimes the market sees value in a stock that’s fallen and sometimes the market is simply spooked. It’s an irrational system, so the market may yield very different responses to almost identical situations.
Quarterly reports sit squarely on the fine line between signal and noise. The numbers and commentaries companies release are the primary tools of an analyst’s trade, but there’s a reason I use charts to track company metrics, rather than merely looking at the numbers. It’s very rare that a single quarter matters that much; context is everything. The broader trend is far more important.
Of course, sometimes a company really is weakening, or making poor strategic decisions. It’s important to know when to react to those fundamental shifts too. When these things happen, there is no advantage in reacting quickly. Patience, research, and perspective will always beat reaction and momentum trades in the long-run.