3 Ways to Make Earnings Season Profitable Instead of Perilous

This week brings us some of the showstoppers in the earnings parade that began a little over a week ago.

The banks were the first big guns to report, and now technology steps into the spotlight with the bellwethers releasing their results – Microsoft (MSFT) and Alphabet (GOOGL) tomorrow, Meta Platforms (META) on Wednesday, and Amazon.com (AMZN) on Thursday.

For a “quant” guy (and total numbers geek) like me, quarterly earnings seasons are some of the best times of the year. We get updated numbers that my Quantum Edge system can pull in, analyze, and use to generate fresh Quantum Scores for more than 6,000 stocks – a process that spotlights the very best companies and the very best stocks to buy.

But let’s face it… earnings season can be scary, too. Especially when we’re careening through an uncertain stretch like we are right now.

Each company’s report is what we often call a “binary” event. There’s a good chance investors will cheer or jeer the results – and the company’s stock will move accordingly.

You can be on the right side of that move – or the wrong one. Here’s how you can use earnings season to make smart choices, to put the odds on your side, and set yourself up for big gains.

The Odds Are In Our Favor

Let me start with this particular earnings season, because it’s an important one.

When uncertainty and fear are running high, stock-price reactions can be more extreme than usual.

If you want a great source for quarterly forecasts, check out a research firm called FactSet. John Butters, the senior earnings analyst there, puts out a weekly report called “Earnings Insight.”

In the latest issue, Butters says first-quarter S&P 500 earnings are expected to decline 0.4%. That would be the fourth straight quarter of year-over-year declines.

Sounds kind of scary, doesn’t it?

But such low expectations actually tip the odds in our favor because those projections are already priced into stocks – especially if you’re already invested in a quality company with strong fundamentals. Analysts have expected an earnings Armageddon since the Covid shutdowns, and it simply hasn’t come.

And best of all, expectations for the current quarter (which will be reported in 2024) are for earnings to grow 6.7%. That’s more like it.

I’ve told you before that that companies almost always beat earnings expectations. It may make us question the validity of those expectations, but it’s true.

Last quarter, 79% of S&P 500 companies earned more than analysts said they would. Over the last five years, the average each quarter is 77% of companies exceed estimates.

It seems counterintuitive, but low expectations lead to more of what investors refer to as “upside surprises” than you see in boom times when stocks are priced for perfection.

Your Earnings Gameplan

A river of financial numbers will be flowing over the next few weeks, and my computers will be working overtime. Sales, profits, margins, and cash are all part of the “Fundamental Score” that helps determine a stock’s overall Quantum Score.

We see more Fundamental Score changes during the four earnings seasons than at any other time of the year, so it will help us identify stocks best positioned to lead the next rally higher.

By the way, peeking inside the Quantum Edge system at this week’s big names to report, I see that Alphabet (GOOGL) has the highest Quantum Score of 77.6, which is excellent. Meta Platforms (META) is next at 74.1, followed by Microsoft (MSFT) at 70.7.

Amazon.com (AMZN) is by far the lowest at 55.2. Its Fundamental Score (which is a subset of the overall Quantum Score) is quite weak at 45.8, well below the other three.

Now, here’s how I recommend you play earnings season.

Rule 1: Go into earnings season already owning fundamentally superior stocks. I’ve found through my research that sales growth, earnings growth, profit margin, debt levels, and valuation are among the most predictive fundamental characteristics of future share prices.

If you own the best and strongest businesses, you’ve got very good odds of an upside surprise or a continuation of already robust growth.

Rule 2: Don’t buy right before a company reports earnings. Earnings are still binary events, and surprises can be negative as well as positive. So if you don’t already own a stock right before earnings, take a seat, grab your popcorn, and watch the show. And then…

Rule 3: Let the data be your guide. (Did you expect anything different from a quant investor?)

Once the report is out, you have the information you need to make an informed decision. If the company’s fundamentals are strong, its price action is favorable, and Big Money is flowing in, chances are high you have a winner.

I’ve found that the two best buying scenarios sound somewhat contradictory, but who cares if they can make you good money?

I like to buy after a company issues a sterling report and the stock shoots higher on big volume. Volume is the key. If a stock pops but only on average or below-average volume, it has a much lower chance of sustaining momentum. This is the Big Money component that is critical to a stock’s upside.

Conversely, if a stock with strength in all three of those components (fundamentals, technicals, and Big Money inflows) dips on earnings – and if the stock is in an established uptrend – it is probably a misguided reaction from investors and a buying opportunity for higher prices down the road.

This is the time for companies to put up or shut up. And it’s the time for smart investors to analyze the data the right way to own the best stocks with the highest odds of making you big money.

Talk soon,

Jason Bodner’s Power Trends