How Average Investors Can Make Huge Gains This Earnings Season
The market logged one of the worst starts to a year with the S&P 500 down more than 5% in January. This doesn’t bode well for the rest of 2016. According to the Stock Trader’s Almanac, a win or loss in January has accurately predicted the course of the year more than 75% of the time.
Whether or not you believe in the so-called “January Effect,” there’s a lot working against the bulls. Namely, revenues for companies in the S&P 500 have declined for four consecutive quarters, and we have gotten confirmation of an earnings recession with two quarters of declining profits.
Much of this is being blamed on the stronger U.S. dollar, which makes foreign sales worth less. In the past two years, the euro has lost 20% of its value against the dollar. This means that an American company that sold $1 million worth of goods in Europe in 2014 is now getting just $800,000 for those same sales.
To maintain the same level of profitability, companies could increase the price of goods. So, the same iPhone that cost 500 euros in 2014 would now cost 625 euros. This kind of price increase usually turns off customers, though, and sometimes drives them to less expensive competitors.
Either way, a relatively expensive dollar is a strain on U.S. corporations, especially those with a global footprint.
Take Apple (NASDAQ: AAPL), for example. When the company reported fiscal first-quarter results last week, management said the strong U.S. dollar robbed them of $5 billion in revenue. That was about 6.5% of total revenue for the quarter.
CEO Tim Cook also stated that they are seeing weakness in the global environment unlike anything they’ve seen before.
Apple is the largest company in the United States and tends to offer more upbeat views in its earnings reports, so if Apple is giving us a warning, we should listen.
We are about halfway through the current earnings season, and the companies of the S&P 500 are on track to show a 5.8% drop in earnings, making it the third consecutive quarter of year-over-year declines.
Luckily, earnings season provides traders with ample opportunities for profits in individual stocks regardless of the overall economic picture.
If you can accurately predict whether a company will beat or miss earnings estimates before its quarterly report, then you are in a position to profit from the post-earnings move. Over the years, I’ve developed a proprietary earnings algorithm that helps me do just that.
With it, I have been able to predict — with good odds — whether a company’s earnings will beat or miss the consensus. From January 2012 to February 2014, I used this system to generate a total return of 424.5%, trading only stocks.
My System for Accurately Picking Earnings Surprises
Investors often take analyst recommendations — whether we should buy, sell or hold — at face value. But in the past 18 years, I’ve learned that there are overlooked details to these reports that tell a much different story. If you know what to look for, these details can spell big opportunity.
What makes my system different is that I analyze the analysts. Rather than sift through thousands of pages of data myself, I let the analysts do the work and then examine their actions leading up to earnings season.
My system essentially looks for patterns of bullishness or bearishness from the most accurate analysts and takes into account just how dramatic their shifts in sentiment are.
For example, if an analyst with a strong track record of good calls lowers his earnings estimate by 20% below the consensus just days ahead of a report, you can bet he’s got a darn good reason. If other analysts are doing the same, even in subtle ways, they likely have information that’s going to impact the earnings report. Those are warnings I want to heed.
I have four main “tells” I look for when I’m analyzing the analysts, and each is critical to my earnings algorithm.
Basically, I figure out the “tells” of good analysts… compare them against a series of technical indicators… and figure out which companies are likely to beat or miss earnings.
Of course, it wouldn’t be prudent for me to share the specific “tells” and indicators. If I did, a lot of people would start using my algorithm and it would become less effective.
But I can show you how it’s used it to make triple-digit annualized gains.
The Smarter Way to Profit From Earnings Surprises
For my example, I’ll use an actual trade we made in railroad company Kansas City Southern (NYSE: KSU).
In early August, the stock looked overvalued and my earnings algorithm predicted the company would miss analysts’ estimates in its upcoming report. With shares trading around $99 at the time, I anticipated an 8% drop to $91.
But rather than advising traders to short shares, I told them to purchase a put option on the stock.
A put option gives you the right (but not the obligation) to sell the underlying stock at a certain price (the strike price) at a future date (the expiration date). This allows you to enjoy all of the downside of the stock with less risk than shorting a stock outright.
Sure enough, when Kansas City Southern reported Q3 earnings on Oct. 16, they missed the mark. But thanks to our put option trade, we didn’t even have to wait that long to profit.
That’s because KSU dropped like a rock after my recommendation, hitting my target after just 17 days. We closed the put option for a 35.9% gain, which translates to an annualized return of 771.3%.
My system has also accurately predicted earnings-related moves in Keurig Green Mountain (NASDAQ: GMCR), Amazon.com (NASDAQ: AMZN), Yelp (NYSE: YELP), Wynn Resorts (NASDAQ: WYNN) and hundreds of other stocks. And I have used options to turn those moves into annualized gains of up to 1,234.3%.
There is still plenty of time left in the current earnings season to book more winners. If you’d like to learn more about my system or get my next trade, follow this link.