Surviving Earnings Season Without Gambling Your Money Away

Nicole Lapin (0:00)

So, four times a year, the biggest companies in America basically have to show all of us their report card, and honestly, it can get pretty dramatic. This is earning season, and if you have ever watched a stock you own swing 15% in a single day and had absolutely no idea why, well, all this will be revealed today. The reason I want to talk to you about this is because earning season is the only time we can predict volatility. Most volatility is unpredictable by nature, right? But earning season will bring volatility. And so once I started understanding the factors driving that volatility, I could both protect myself and take advantage of it. So public companies legally have to report their financial results every single quarter. These results get filed in a proper document, but what most people actually tune in for is the earnings call. It's a live scripted but also not so scripted spontaneous event where the CEO, the CFO, and sometimes other executives walk through the numbers, share their outlook, and then open the floor to questions from Wall Street analysts. It's like a quarterly performance review, but in front of thousands of investors with the stock price reacting in real time. So it can get kind of juicy. These calls happen roughly in January, April, July, and October when companies report results from the previous quarter. So right now, we are squarely in Q3 earning season. Some of the biggest names in the market, the MAG 7, the big banks, the major retailers are all reporting within a few weeks of each other. It's a financial news fire hose. The headline numbers are revenue and earnings per share. Earnings per share or EPS is the profit divided by the number of shares outstanding. It's essentially how much money the company made per share. These are the numbers that get compared to Wall Street's estimate. And this is important. To get these estimates, a team of analysts at major banks spend months trying to predict what a company is going to report. They build models. They talk to suppliers. They run surveys. They even track satellite images of parking lots. I am not kidding. I kind of wish I was, but that is real life. Those predictions get aggregated into a consensus estimate. That number is everything. As far as the stock market is concerned, actual profit matters less than whether the company beat or missed estimates. Now, beyond revenue and EPS, guidance might be the single most important thing on an earnings call. Guidance is the management's forecast for a company's future performance. These might be outlooks on expected revenue or earnings. A company can beat estimates for the current quarter, and their stock can still get crushed if they lower their guidance for the next quarter. Seriously, the stock market is so forward-looking as a machine, it doesn't really care as much about what just happens as it does about what's coming ahead. When I explain all this to my clients at my firm, Private Wealth Collective, I give two examples that happened to the same company roughly one year apart. Back in February of 2022, Meta reported its Q4 2021 earnings. At that time, the company was riding high on its Facebook, Instagram, WhatsApp empire. Revenue was basically in line, but the company disclosed that daily active users on Facebook had declined for the first time ever, by about half a million users. Plus, their guidance was weak. The stock dropped 26% in a single day. That wiped out roughly $232 billion in market cap in 24 hours. That is the largest one-day loss in market cap of any company in the US stock market history. $232 billion because of one bad metric in one bad earnings call. This is why I ask CEOs that come on the show if leading public companies suck. And sometimes the answer is yes. I had a funny conversation about this with the co-founder of Lyft, John Zimmer, a few years ago, and I'll link that conversation for you in the show notes. But back to the second story. In April of 2023, Meta reported its Q1 results after a brutal 2022 The company posted better than expected revenue and said it was cutting costs aggressively calling 2023 the year of efficiency. The stock had already climbed from its lows, but it had jumped another 14% after that call. Investors had been scared. The guidance reassured them. That is all it took. Now, there is a wild category that I'll include here as an honorable mention. That's companies that miss expectations badly, but then somehow go up anyway. This happens when the miss was already priced in, so to speak. That basically means that investors had already sold off the stock in anticipation of bad news. So when the numbers came in and weren't that bad, the stock actually pops. This is what's called a relief rally, and it can actually make you crazy if you watch it too closely, so try not to. Because the company literally reported bad numbers, and then the stock goes up. This is why earnings season can feel absolutely insane to regular investors trying to make sense of it. So what we should actually try to do around earnings season? My hot take? Absolutely nothing. The thing everyone wants to do is buy a stock right before it reports, hope it beats expectations, watch it jump, sell it, collect the profit. It very rarely goes like that. Here's the problem. By the time you've deduced that a company is going to have a good quarter, every professional on Wall Street has already had that idea and traded on it. The current stock price already reflects the consensus view. For you to make money on an earnings beat, the company has to beat by more than the market expected. A surprise above the already high expectation. And you, as an individual investor, almost certainly do not have better information than the Goldman Sachs analyst who was covering this company for 10 years already, talks to its suppliers every quarter and literally models satellite data of retail parking lots. That is why the house always wins. You know, there's also a volatility problem. A lot of traders try to use options around earnings, buying calls if they think the stock will go up, buying puts if they think it will go down. Remember, call up, put down. If this sounds like absolute gibberish to you, I've linked another episode in the show notes where I go into blocking and tackling of options trading. Basically, traders try to hedge their bets. But here's what ends up happening. Like I said earlier, everyone knows that earnings season is volatile. So in the weeks before an earnings report, the implied volatility on those options spikes dramatically as traders bid them up. That spike inflates the price of the options. Then the moment the earnings come out, even if the report is great, that implied volatility basically collapses. This is what's called a volatility crush and it can wipe out your options position even if you got the direction right. You picked the right outcome and you still lost money. If I'm being real here, this part of it is just gambling. So what is a regular investor supposed to do? Like I said, probably nothing.