Earnings season can prove to be a fantastic boost for a stock's price or a very disappointing result. Luckily there are ways to minimize downside risk while still capitalizing on any strong results that cause a stock to surge higher.
Overall there are three primary factors involved with how "the Street" reacts to earnings:
- Actual results - Did the company meet or beat analyst expectations? This includes net profit, revenue, earnings per share, miscellaneous charges and expenses accrued during the past quarter and/or fiscal year, etc.
- Surprise announcements - This could be announcing a share buyback, increased (or decreased) dividends, etc.
- Forward guidance - Guidance is a huge interpretation piece. A company can kill its earnings but lower its forward guidance and start selling off without remorse. The contrary is true as well with announcing an increased expectation of earnings to come.
With this in mind it is important to note that anything can happen after earnings are announced and the call takes place as everything is subject to interpretation. For example, sometimes the more hype there is for positive earnings the more prone the stock is to reversing and selling off on the results.
Here are six great ways to lower your exposure to a potentially negative response and subsequent stock price sell off:
1. Go off any margin - This is a no brainer and with so much at stake it is a big first step to minimizing risk. If the stock gaps down 10 - 20% your portfolio may very well be subject to a margin call which would could force you to liquidate other positions to raise cash.
2. Sell half your position (trim exposure) - Alongside getting off margin, trimming overall exposure is an easy way to reduce risk while still giving yourself the potential to make money if the stock does report strong results and moves up in price. You can always buy back your shares the next day if desired.
3. Use options - Using options opens the door to endless possibilities to hedge risk or increase exposure. Selling covered calls, buying puts, etc. Here are some great options tips for getting started.
4. Raise / tighten stop loss orders - Stop losses are very useful in lowering risk as the order will automatically sell you out of a position if the stock hits a pre-determined price. Know though that if a stock gaps through the activation price then the order will not trigger. Read this article for stop loss order tips.
5. Watch and trade the stock real-time after hours - If you have a good online stock broker then you will have easy access to viewing after hours action live as the orders come through. Using limit orders and a quick finger you can buy or sell shares after the earnings are released.
6. Pray to the investment gods - This can be used in combination with any of the above concepts. Warning though, results are not guaranteed and may vary drastically from your intentions :).
Every investor has a different risk appetite and thus for some investors the above tips may be completely out of the question while others may already be applying them in their own portfolios. In the end it is up to you to determine what works best for you and your investment strategy so stay sharp and good luck!
UPDATE: This article was included in the latest Carnival of Personal Finance.