The greater the degree of uncertainty, the greater your risk in holding a position in a stock. All stocks are uncertainties, but there is no moment of greater uncertainty than that of an earnings report. It’s the time when the company reports on how well it is doing now and how well it expects to do in the future. Often times, other major announcements are made as well. It can be a time of extreme volatility, especially with small cap, high growth, CANSLIM style stocks. Sure, the upside potential can be great, but there are too many things that can go wrong, which could cause the stock to plummet. Remember, the name of the game is preservation of capital. You can always repurchase the stock once the coast is clear.
A company may report below analyst estimates, or the whisper number (earnings that the company is rumored to report, often leaked by an insider). There are times when a company will beat the analyst estimate, but not the whisper number and sell off.
They may release negative news about the company, the industry, or reveal a less than optimistic outlook for the future.
“Buy the rumor, sell the news”. Often times a stock will rise ahead of expected good earnings, only to sell off once the great earnings are released.
Here are a few recent examples:
AU Optronics (AUO) recently reported blowout earnings on April 27 and has been plummeting ever since. While the weakness in the market is to blame for some of the selling, it’s a classic case of buy on the rumor and sell on the news. Investors sent the stock soaring nearly 100% since the last earnings report, expecting the company to continue to report great earnings.
Tumbleweed Communications (TMWD) is a fast growing provider of spam, virus and fraud protection software that reported less than stellar results on April 27th and promptly sold off. It’s down more than 60%.