If you know what information to look for, how to utilize that information and understand the risks involved, then you can profit from earnings like the pro traders on the floor. The playing field is beyond leveled. Let me explain.
Trading on the Exchange
It was 1997, at the time I was trading DELL Computer (DELL) options on the Philadelphia Stock Exchange; the Internet as we know it wasn’t available, stocks and options were traded in fractions, there were no Smartphones, no Internet trading, no iPads or iPods or any of the tools we have today.
In fact, it cost roughly $1,200 per month just for me to get stock quotes and basic market news & research. My first Hewlett Packard handheld computer that I used to generate the value for my option trades (pictured below) cost roughly $1,000 + several hundred dollars a month to lease the trading software.
All in, I was paying close to $5,500 per month just for the privilege of trading with about as much information as you would find on any Zacks webpage.
The most ironic thing about all this is that I was paying to be FORCED into trades. You see, as a market maker (floor trader), it was our job to quote bids and offers at all times, meaning that at any time we had to stand prepared to buy or sell no matter what the market was doing.
Despite the costs, stress and impending Y2K dilemma that we thought was going to end the world; times were good. We made easy money because most retail investors didn’t have access to resources and/or education. It also wasn’t feasible for most to pay $3,000-$5,000 a month to get the edge they needed.
This “information gap” led to many mistakes by many investors, or they were simply giving up profits because they weren’t abreast of developments as quickly as we were. Our advantage was amplified during earnings when stocks made their biggest moves.
It was almost a sure thing that we could profit from quarterly earnings reports. It wasn’t anything illegal, we just knew the results instantaneously and could buy or sell before most investors, and then watch the stock move as the information spread. There wasn’t even a need to research analysts’ commentaries or details of the report; just act fast and wait for the masses to pile in after you.
The analogy would be that retail investors were getting data at the speed of a horse, while we had it delivered by car first and were able to act faster.
I knew it couldn’t last…
15 Years Has Changed Everything
When I first interviewed with Zacks, Sheraz Mian had me “check out” the Zacks.com site. I remember being astonished at the plethora of quality information I found on their website (and for free). At the click of mouse I could find out everything I needed to know about a company, but more importantly I could visualize what the analysts were doing (great for earnings) and get a professional’s digest of what a certain news story meant in real time!
I knew a while ago that we floor traders are a dying breed, replaced mostly by computers or off-floor traders with computers so fast they will make your head spin. But as I started to work with Zacks and found out more about what goes into the “special sauce,” I realized that the playing field was leveled; but it also evolved into an elusive game.
Playing the Game
We live in a world of noise – news, earnings, commentary, tweets, twits, Facebook updates, blogs and so much more are all available instantaneously to anyone who knows where to find them. The problem is sifting through the clamor and unqualified opinion to get the real story and most probable outcomes and profitable trades.
Earnings reports are now clouded with random bloggers and reports from sources that I have a hard time trusting. Just about anyone can pose as an expert on the net, and I have often found that those who are good at getting recognized on the web are not necessarily the best ones to listen to.
I find clarity in analysts and with the companies themselves. Analysts may not be traders, but they spend most of their waking hours researching a very small group of companies and often know those companies almost as well as the executives that run them.
Analyzing their behavior is instrumental for gaining real insight and is the foundation of Zacks. The Zacks Rank is an effective means of measuring not only the sentiments of analysts, but taking an amalgam of other data and translating that into a rank number of 1 to 5.
Analysts and the fund managers that work closely with them are what I classify as “Smart Money,” mainly because they have a ton of it and when they move that war chest around, stock prices tend to follow suit; usually in a big way.
If we can find the best way to “ride their coattails” into and out of stocks, then you can bet the chances of success are greatly increased.
Follow the Smart Money – Use the Zacks’ Tools
The goal of the Zacks Rank is to effectively follow the earnings trends of companies and, in effect, the smart money trends. Following the Zacks Rank is one way investors can stay in outperforming trades for longer periods.
As a market maker, I prefer the quick action; most of my trades in the Whisper Trader Service are less than 7 days in duration and all take place around earnings. The benefit of shorter trade lengths is that my exposure is purely based on what I see happening in the analyst area and usually has less correlation to what’s happening to the broad market.
To get a handle on where the Smart Money is going in the short term, I look for high profile analysts (or accurate ones) making relatively dramatic shifts in sentiment or their target just ahead of a report. If the consensus is for $1.00 in EPS (earnings per share) and an analyst from J.P. Morgan (JPM) ups his EPS expectation from $0.99 to $1.25, that’s a tell tale sign that he might know something or believe so strongly about something that it might be worth further investigation for a buy.
This action can be seen on our Earnings Detail page and is expressed as ESP, as shown below.
In the above image, we are viewing the ESPs for Wintrust Financial (WTFC), which was recently added to the Whisper Portfolio. Aside from its favorable analyst momentum, the mid-western bank finds itself positioned well for growth and is making acquisitions to expedite that goal.
Shares are slightly rich at 18 times forward earnings, but there could be some legs to the bullish trend the stock has been on. I’d be a buyer going into the earnings report tomorrow.
Are Analysts in Agreement?
I use another measurement in the Zacks Earnings Screen to see how many analysts are getting bullish or bearish ahead of a report; notice the number of upward revisions vs. downward revisions. Think of the below screen as a show of hands for a stock going higher or lower; the higher the “up to down” ratio, especially just ahead of a report, the better.
Early last week we took a signal in Whisper Trader and bought Goldman Sachs (GS) ahead of its report on October 16th. In the days that followed, Goldman rallied 3% and several analysts noted that it’s likely that they will beat estimates tomorrow.
Goldman, which is still one of the world’s foremost investment banks, has an earnings ESP of 2% and is trading at just 10 times earnings; just a couple more reasons why I also like Goldman Sachs at these levels.
Just How Bullish (or Bearish) are Analysts?
In the chart below we see the estimates for Chesapeake Energy (CHK), which is not in our portfolio, but is a favorite of mine. Notice how the top four estimates have all either revised higher or at least reiterated their targets for the quarter. This is another tell-tale sign of a stock that might beat the Zacks Consensus Estimate.
I use this screen to spot the details of just which broker is making what moves and get a real sense of where he or she stands in relation to the pack.
I combine all the results of all these tools and other research to pick my stocks over earnings.
CHK is no doubt on my radar when it reports earnings on November 1st. I’ll be watching analyst movements closely, but with an earnings ESP of 33% and a high ratio of positive analyst revisions in the past 30 days, it looks pretty darn good.
Unique Diversity
In markets that are uncertain, it’s beneficial to have analysts and big brokerage houses on your side if you are take a position in a stock. Reputable and large firms drive seas of brokers to buy (or sell) a stock and can help support a stock in a weak market if they are recommending it as a buy.
Trading earnings with a portion of your portfolio is an excellent way to add diversity to your portfolio. Right now, I know that many investors have cash sitting idle which can be at least partially invested in earnings trades from my Whisper service or in trades that you research on your own.
The problem is finding these trades. I pointed out a few stocks I thought looked good this season, but it can get really tedious combing through the stock universe looking for the optimal situations.
Zacks realized this and created an algorithm that sifts through thousands of stocks looking for all of these elements and more to find the best stocks to trade over earnings. This algorithm drives my Whisper Trader service and we are close to 82% accuracy in targeting stocks that beat the Zacks Consensus.
Zacks has taught me that you don’t need to have an exchange seat or pay astronomical fees, nor do you have to sit next to a fund manager to get insight; smart money leaves a trail of breadcrumbs.
You just have to know where to look for them; they can get very easy to spot just before an earnings report especially if you have a service like Whisper to help.