Earnings season is officially underway. The release of quarterly figures paired with widespread market volatility is a recipe for big swings in the prices of individual stocks. But that’s just the price action side of earnings season.
For long-term investors, earnings provide a way to look under a company’s hood by reading its financial statements, listening to management commentary on conference calls, and diving into transcripts and presentations to hold a company accountable for its goals, find hidden gems, and identify red flags.
Earnings season is a great time to learn about new companies and get up-to-date information on companies you already follow. But many investors approach earnings season the wrong way, and could even develop bad habits that lead to losing money. Here are three big mistakes to avoid this earnings season.
1. Banking on a good quarter
One of the most common mistakes investors make during earnings season is banking on the quarterly results to surprise Wall Street estimates in the hopes that the stock price goes up in the short term. A stock price can pop after a quarterly report for various reasons. Maybe the company sandbags its results and surpasses expectations. Or the company has a lot of momentum and seems to be able to do no wrong. Or, on the flip side, maybe the stock price is down, and so much bad news has already come to light that it’s hard to imagine the situation getting much worse.
The reality is that no one knows what will happen in the short term. But no matter the reason, banking on a good quarter is never a good idea. Yes, we all want our companies to have great quarters. But betting the farm on a single quarter or hinging the investment thesis on a three-month time period is a great way to lose money.
2. Overweighting a single quarter
Another common mistake investors will make during earnings season is focusing too much on quarterly results or simply making them a bigger deal than they really are. Quarterly results are useful, but they only tell part of the story. Quarterly results are inherently biased based on several factors such as seasonality, broader macroeconomic factors, timing, luck, weather, etc. Judging a company’s worth or overweighting a particular quarter is like judging an athlete’s skill based on a single playoff series, or a student’s academic prowess based on a single report card.
The better approach is to digest the quarterly results and management commentary and thread them into the overarching investment thesis to determine if the company is a reasonable value, and if it’s hitting its objectives, growing, staying competitive, innovating, has solid management, and whichever other metrics you want to look at.
3. Buying or selling a stock based on quarterly results
This leads us to our next point: buying or selling a stock simply because a quarter was good or bad. Stocks can make huge moves post- or pre-market due to their quarterly figures. And while Wall Street and short-term traders may feel inclined to make flinch reactions, individual investors probably shouldn’t follow their example.
However, there are cases when it’s ok to buy or sell a stock after its quarterly results. If the fundamental investment thesis is broken and the company no longer looks like a good long-term business, then maybe it’s time to reconsider the position. Conversely, today’s market offers several impeccable buying opportunities with stocks down big off their highs. If a company on your watchlist falls after reporting earnings and the investment thesis remains intact, then buying the stock on sale could be a good decision. It’s important not to try and time the market. But all else being equal, if you liked a stock at a higher price, it becomes an even more compelling buy on sale.
Always remember to zoom out
It’s human nature to get caught up in the present, especially when the Nasdaq Composite and S&P 500 are in a bear market. At times of high uncertainty, many investors may be hoping that a good earnings season can provide the antidote needed to turn the corner on the bear market. However, the better approach is to view the bear market as simply a moment in time along your broader investment journey.
When it comes to individual stocks, certain businesses have a habit of outlasting bear markets. These companies tend to gain market share during bear markets thanks to strong management and solid balance sheets. Buying these companies during a bear market can lead to life-changing wealth for patient investors with multi-decade time horizons. So instead of getting immersed in a particular quarter, always remember to zoom out and take a measured approach to earnings season.
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