The Earnings Trap

I've mentioned before that holding a stock over its earnings can be very risky. If you're a long term investor, then perhaps you don't have to pay attention to earnings dates, but by not doing so can be detrimental to your portfolio, at least in the short term. Witness the chart of Ameron (AMN).

Ameron reported earnings on Feb. 26th. You would think by the 25% one day price drop that earnings were ugly. Had they badly missed estimates? Were there accounting problems? Had the CEO and CFO absconded with corporate profits? The answer is: none of the above. In fact the company reported a healthy 24% gain in sales over last year's quarter and a 14% jump in earnings to $1.07. So what was the problem? The problem is a combination of two things. Although sales beat Wall Street estimates, earnings fell short of the $1.30 estimate. Strike number one. This fact was exacerbated by the recent run-up in share price which reflected investors anticipation of good earnings news. However, their hopes were quickly deflated by the actual numbers thus contributing to the stocks quick and dramatic decline.

If you want another stock that is pooping out on good earnings news, look at the action in Cal-Maine Foods (CALM).

They reported before the market opened this morning. For the fiscal third quarter, they reported higher sales compared with a year ago and their earnings per share tripled, from $0.74 to $2.41. Wow! (As a note, they did not offer any negative guidance and in fact said that they're going to start paying dividends.) In pre-market hours, the stock was trading up. Now, at the close, the stock not only gave up its pre-market gains, but is down over 17% from its intra-day high. This is the stock's biggest one-day loss in a long time.

These two examples aren't unusual in the least. As I've mentioned previously, the stocks that stand the most to lose from a less than stellar earnings report are the ones who have the most expectation built into them. They're the ones who have become market darlings, so if you own some of those, you may want to pay particular attention to their earnings release dates and perhaps lighten up on your holdings before then. (Another way to minimize your risk is to write covered calls or buy protective puts.)

I hope this brief tutorial has been instructive. I want you to be armed with the knowledge that it's in your power to protect your portfolio against potentially large losses due to earnings releases.