Sudden Share Price Movements: Profit Announcements

Prior to a profit announce, the share price of a publicly-listed company builds in a profit expectation.  As shown on the chart below of Aristocrat Leisure (ALL) in September 2007 when the company released forecast FY07 profits, the market reaction was unforgiving as institutional analysts re-calculated expected dividend yields while funds hastily re-balanced their portfolios.

The announcement was scheduled and it demonstrates the dangers of short-term trading, especially during the normal reporting season. Technical analysts who study the charts over many reporting seasons see something quite startling: the chances of an individual stock selection moving in line with the short-term technical indicators is at best, uncertain. The fact is, the risk-reward scenario of holding a CFDs or Options overnight when the company is about to report is unfavourable.

From experience, more short-term CFD and ETO traders get hurt during earnings season than at any other time of the year.

Why? There are several mechanics at work during an earnings release. Firstly there are the raw numbers themselves. Did they actually beat the estimates? Sometimes it appears as they have, but how’d they do it? If they did it on falling revenues, then they accomplished the feat by cost cutting or playing the currency spreads. None of them are indicative of great growth. Then we have the issue of just how much did they beat the estimates by? Quite often beating the estimates can be more a matter of creative accounting than a real estimate of business growth.

Moreover, the short-term technical analysis generally supports the jawboning of the analysts and their estimates. The CFDs and ETO trader sees the stock price moving with the expectations of the analysts, encouraging the trader to enter the trade. The next morning the company announces their earnings and “whack” the share price gaps down or falls quickly, despite the fact that they beat the numbers.

Guidance

Secondly, there is the all-important “guidance”. The earnings released is already old news as they represent the half-year that has already past. Fund managers and analysts are very interested in what the company is doing now and what they think they will do in the future. If the guidance is less than encouraging, the stock may well take a knock.

Unannounced profit warnings can be even more of a shock to the short-term trader.

In the chart (right) Caltex Australia Ltd. (CTX) had been climbing steadily over the period 12th to 21st June 2007, aided by a climbing Singapore exchange petrol price. On the 22nd June 2007 it announced that first -half (2007) net profit after tax is expected to be between $355 million and $375 million, which was up from $276 million in the first half of 2006. One would expect that an increase in profit would be good news for the Caltex share price. However, Caltex opened 3% lower and quickly dropped to a level that was in excess of 8% off of the previous closing price.