Back in a different life I used to trade earnings reports quite a bit (one of many strategies I used). I used to run a really arduous model combing over quarterly reports trying to find inefficiencies. I was essentially competing with the analysts and trying to beat them at their own game. It wasn’t hard to do really because the earnings game on Wall Street isn’t terribly complex. And you could literally pick out patterns in certain reports and once you traded the reports for 8 quarters plus you knew how every name responded 75% of the time. It was brutal work because it required a HUGE effort to get through the reports and build the model for analyzing the report, but it became a bread and butter strategy for a long time before 7 years straight of waking up at 3AM to trade an east coast earnings report 50% of the year ran me into the ground.
Anyhow, I loved this piece in the WSJ this morning on earnings. The way an earning’s report works is funny. No one really knows what the company will report so when the press release hits at 6, 7, or 8 AM EST the market is totally rattled for the first 15 minutes. It’s the most hilarious case of inefficient markets you’ll ever find. The reports are dense. And the negatives and positives are largely unknown for most companies until you’ve had 30 minutes or so to digest the report. Are revenues strong? Are operating margins strong? Why did EPS miss? Did they have a funny charge? Was the quarter 120 days or 119 days? Did they buy back stock to boost EPS? How is the apples to apples comp? There are SO many variables here and a lot of the time it’s like no one has any clue what’s going on. In fact, I’d gotten so good at understanding the reports that I used to just slam guys with order executions within minutes of a report release because I knew the stock, I knew how it tended to respond, I knew the order flow, I knew the reports, I knew the management team’s tricks, etc and I knew when someone was putting in a silly order. The spreads are so fat in some of these names in the arter-hours or pre-market that you can really rip someone’s face off if you know what you’re doing. It was like playing a real-time game of chess except you always had an edge.
But the most enjoyable part of the reporting session is always the conference call. This is the time when you get to hear the relationship that management has with the analyst community. It’s a fascinating dynamic because management wants to feed the analysts some idea of how business is (because really, the analysts have no friggin clue) because ultimately, it’s the analyst reports that could slam the stock. So you want to put on a happy face about business, but you don’t want to be too happy. I used to love the companies that would beat on the quarter, cut next quarter and raise the full year guidance. To me, that says “management knows how the game works” and they’re underpromising so they can overdeliever, but they’re raising full year guidance because they know they’ll outperform and the analyst’s can input the full year guidance into their model and raise EPS estimates. GENIUS!
But what I really used to love hearing was “great quarter, guys”. “Oh, thanks Jimmy!” – Said CEO Joe Schmo (they’re all on a first name basis with each other because they all know each other at this point). “Great quarter, guys” was basically code for “upgrade coming your way!” So you’d hang onto the stock until the open, let the market buy the news and sell to move on looking for the next “great quarter, guys”. What a funny world, this investment world is. If the public only knew all the inner workings of it all they’d probably barf all over themselves….
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.