What Matters Most: Performance or Guidance?

Dear SlingShot Trader Subscriber,

Earnings season is full of trading opportunities, but the underlying factors that traders pay attention to will differ from one quarter to the next. Sometimes the most important numbers will change from week to week depending on overall market conditions. This earnings season has been a lot like that, with the emphasis switching from actual top and bottom numbers to guidance. This means it is possible (and lately it has been quite likely) that a good profit report will lead to a decline in a stock.

What constitutes performance?

The earnings announcement’s primary purpose is to report a company’s financial performance to their shareholders. However, non-shareholding analysts tend to pay the most attention to these numbers and will publish their own estimates of what to expect from revenue and profits. Ideally a company should report top line (revenue or sales) and bottom line (profits) that are growing compared to the prior quarter or at least when compared to the same quarter over the last year.

Management uses this quarterly disclosure to discuss performance with shareholders and analysts. They should explain why profits were up or down and discuss any fundamental changes in the company. Analysts and some shareholders will have developed their own estimates or “expectations” of what these numbers will be and a miss (negative) or surprise (positive) can make the stock’s price move a lot before it opens for trading. At the start of this season positive surprises were very low and although they have improved it has still been slow.

Whose expectation is being used?

Because estimates are usually reported as just one number, many stock traders assume that analysts are aligned in their estimates. However, there is usually a wide range of estimates, and what is being reported is just the average or mode of that range. For example, Aflac (AFL) just released earnings last night with “expected” profits or earnings of $1.52 but that was actually just a weighted average of 20 estimates that ranged between $1.47 and $1.67 per share. The company reported earnings of $1.48, which was technically a miss.

Despite the miss, AFL’s stock didn’t drop in post-market trading last night, and is flat so far today. At one point the share price was even positive, which may seem a little confusing at first but should help illustrate the difference between the so-called analyst expectations versus market expectations. The change seems most likely due to strong guidance that was in line with future expectations.

Like stock investors, analysts and management teams are also trying to forecast the future. Management has access to the most information, and should theoretically be the most accurate in their estimates. They will disclose some forecasts as guidance to shareholders and analysts, as a way to increase transparency and reduce stock volatility. Guidance can have an even bigger impact on the stock than the prior quarter’s actual performance.

Guidance is the most important factor this earnings season.

For example, Radio Shack (RSH) was scheduled to release earnings three weeks from now. Expectations were for a decline, but the firm’s management team decided to pre-empt their February earnings report with new “guidance” yesterday morning. The stock dropped 30% on the news that profits for the last quarter would miss expectations by an estimated 75%. That is a big adjustment, and is actually a fairly unusual change, but it makes the point about how guidance can overwhelm profits (they were still expecting to be profitable.)

Guidance is also more subtle than what was issued by RSH yesterday. It can be created by management during the call with analysts and shareholders just after the earnings report is released, when they discuss economic expectations, research and development or even changes in the management structure. Quite often, small changes in guidance can change the reaction to a soft or bad announcement or vice versa

Autoliv (ALV) released earnings this morning, and it missed its revenue estimates and just met profit expectations. However, the stock is up because they increased guidance for the coming year. Traders were willing to overlook the revenue miss and bid prices up this morning. However, if we go back a couple of quarters the situation was very different. In July 2011, ALV killed profit estimates by 20% but dropped 28% over the next month. The difference was soft guidance for the coming quarter, and expectations for an ongoing lawsuit.



Autoliv (ALV): Chart Courtesy of MetaStock

How this changes our strategy this week:

Right now, the market seems to be emphasizing the upside guidance much more than anything else. That will bias us a little further to the upside, but the trend is still fragile and we want to remain flexible. Much of the change will be in determining which companies are most likely to increase guidance. Right now, that favors manufacturing, retail and technology. It even seems possible to see improved guidance from the financial sector, but we aren’t ready to assume that yet. This gives us some additional direction for where to look for new bullish trades as long as the market is still robust.

This Week’s Events

Earnings are still middling so far this season, but economic reports have continued to look relatively good. Greece remains an issue, but so far traders seem confident that the future debt settlement is priced into the market. We expect earnings to continue to add to market volatility for the next week, but Friday’s labor data will likely set the tone for next week.

Feb. 1 – Qualcomm Earnings – After Market Close

Feb. 2 – Merk & Co Earnings – Before Market Open

Feb. 3 – BLS Labor Report – 8:30 a.m.

Feb. 3 – Beam, Inc. Earnings – Before Market Open

Feb. 6 – Coinstar Earnings – After Market Close

Feb. 7 – Coca Cola earnings – Before Market Open


When it’s time to open or close a trade, we’ll send you alerts via email. You also can sign up to receive text messages regarding our trades. For more info about our SlingShot Trader portfolio, you can read trade alerts here.


Positions Opened

These are the SlingShot Trader positions we opened during the past week of trading.

Feb. 1 – Buy to open the CSTR Mar 50 Calls for a maximum price of $4.00.

Jan. 31 – Buy to open the AOL Feb 16 Puts for a maximum price of $0.65.

Jan. 30 – Buy to open the QCOM Feb 60 Calls for a maximum price of $1.20.

Jan. 27 – Buy to open the BEAM Mar 52.50 Calls for a maximum price of $1.50.

Jan. 26 – Buy to open the PFE Feb 22 Calls for a maximum price of $0.19.

Jan. 25 – Buy to open the CB Feb 70 Puts for a maximum price of $1.45.


Positions Closed

These are the SlingShot Trader positions we closed during the past week of trading.

Jan. 27 – Sell to close the CB Feb 70 Puts for $2.95. Originally purchased for $1.45.

Jan. 31 – Sell to close the PFE Feb 22 Calls for $.09. Originally purchased for $0.19.

Feb. 1 – Sell to close the AOL Feb 16 Puts at market. Originally purchased for $0.65.

Top Trades Now

These are the current SlingShot Trader positions that we still recommend getting into now, assuming you can get in for the advised price or better and haven’t already bought a full position.

Jan. 27 – Buy to open the BEAM Mar 52.50 Calls for a maximum price of $1.50.

Jan. 30 – Buy to open the QCOM Feb 60 Calls for a maximum price of $1.20.

Feb. 1 – Buy to open the CSTR Mar 50 Calls for a maximum price of $4.00.

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If you can’t attend the session live, you can watch the archived versionon our website in the “Live Weekly” section. It’ll typically be posted within about two hours of the end of the live session.



John Jagerson and Wade Hansen
SlingShot Trader