4/01/2007

How to trade earnings Part3

Here are answers to most asked questions on earnings breakout so far. The concept is simple to find unknown stocks having significant earnings or sales acceleration for the first time. To make it work you need to have a well thought out methodology.


Other Data Sources:

What you need is good quality, reliable and timely earnings data. There are several sources of earnings data like Bloomberg, Thomson, Zacks, Reuters, Wall Street Journal, Investor Business Daily, S&P , Briefing etc. Basically more or less there are only 3-4 major data providers to most sites, so you will find same data everywhere e.g. the WSJ site data is provided by Zacks.


Earnings Cut off

Now you need to decide on earnings growth rate cut off. Anything less than 25% is not worthwhile. Higher the better. I also do not look at earnings of less than 5 cents per share, because doubling 1 cents to 2 cents is 100% but may not be worthwhile. If your cut off is say 25%, depending on market circumstances you will get 1500 to 1000 stocks. I use a higher cutoff of 100% to further reduce the universe. This gives around 200 to 700 stocks based on where we are in economic cycle. Stocks which announce 5% earnings or negative earnings also start rallying post earnings. The reason being thy might guide higher for next earning season. Similarly a company having very high earnings might tank post earnings if its future guidance is low or if that earning is happening after a major price move, where it is already discounted.

Sales Cut off
This one is little tricky. There are many industries where growth of 25% may not be possible. But again it is safer to take higher cutoff.I take 5% but you can use 25% plus and further reduce your tradable universe. In ideal scenario, you must strive to find both very high earnings and very high sales growth. Such hyper growth scenarios, if they are complete surprise can kick off virtual stampede. TASR was one such case.

Price Reaction

The stocks reaction to earnings is critical. Three things will happen after a significant earnings 1) immediate breakout 2) no reaction stock continues in range (this might breakout later closer to next earnings) 3) reversal ( this typically happens after a string of earning surprises and significant price growth).

Once you do this for extended period of time you will learn more about how these stocks behave over long periods. You will also get most of the big movers before most people have even heard of them. You will be able to tell weeks in advance which stocks will make it to IBD100.

Why not scanners
The most critical part in this is building your own databases. If you use scanners to get this data, you will not get same results. The most scan data is batch processed with significant time lags in many cases. The earning change will get reflected in most scan after 24 to 48 hours in some cases after a week. Most free online scans have data lag, that is one of the reason, they are free.

How is this different from the IBD EPS ratings.
IBD EPS ratings are good but the way they are calculated they tend to lag on certain set of stocks. Especially stocks which had string of losses for many quarters and become profitable ( which is the case in many new companies or turnaround situation). Another thing is IBD waits for earnings momentum to build before entering. In many cases companies have outstanding earnings only for 1-2 quarters. They immediately react to the earnings. The IBD EPS and Relative strength rating increase , they form cup and handle and then breakdown.
If you track the before and after earnings ratings for IBD EPS, you will notice the change after earnings season. If you read the IBD New America section carefully, you will notice many stocks highlighted are the triple digit earnings stocks, which recently had acceleration in earnings or sales.

Once I have the database I continuously rank it by price appreciation. The objective is to continuously look at top 25 price performers post earnings for opportunities. I also look for sector trends in this earnings data. You will be surprised at the longevity and strength of some trends post a stock had an earning/sales acceleration. Such trends last years. Go back and see the commodity sector or oil and energy sector, the stocks in that sector had triple digit acceleration 3-4 years ago and they are still rallying.

Typically in my experience of interacting with traders who have mastered this strategy, it takes at least 2 earnings season to get better hang of this. But the rewards of persisting with it are very good. After all it is statistically proven anomaly.

Later: Earnings and Bulkowski

Related posts :
How to trade earnings Part2
How to trade earnings
Earnings Season- Time to be very careful...
Earnings and Dan Zanger
Earning Surprise System for $1495
Trading Earnings Breakouts
Earnings Acceleration- Long Term Impact
Trading Earnings Breakout -Part1
Trading Earnings Breakouts -Part2
Trading Earnings Breakouts -Part3

5 comments:

volstreet said...

Thanks for all your posts. How long do you stay with a stock if you are not stopped out. Any rules? How many stocks should a person hold at one time? thanks Vol

KN said...

volstreet
all those questions have been answered in previous posts, Just do a search on the blog and you would get all you need

Pradeep Bonde said...

Volstreet
How long do you stay with a stock if you are not stopped out.

Months, years

How many stocks do I hold?
4-5

How many should you hold?
Concentration builds wealth, diversification protects wealth. So it depends on what stage in wealth cycle you are.

jbu said...

So Let me make sure I understand,

You don't build your database through scans? You are physically building it (IE. Ledger) from info you gather through IBD or Briefing, etc.. on postive or negative earning surprise which meets your earnings criteria?

Sorry for sounding so simplistic and a little stupid but just trying to get through my feeble brain what you are doing and how you're doing it.

Thank you for all your insight

Pradeep Bonde said...

Scans have outdated information, because they use batch processing with delay of 1 to 7 days to update their earnings database.

Earnings trade works instantaneously after earning release. Some time stock making 20 to 500% plus move in few days or week. If you don't get in on earnings day, there is no safer low risk entry on it during the fast and furious move.

I build my database from IBD. I am not interested in every earnings, only in small number of stocks earnings which meet my criteria.