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Earnings season, investing and you

By Dr. Don Taylor ·
Monday, July 28, 2014
Posted: 6 am ET

It's earnings season. Stocks can see big changes in their price based on the information released when they report their quarterly results and offer guidance about the firm's future prospects. Information moves markets, but should individual investors try to anticipate financial results in an earnings report or react to the release of those results?

Individual investors don't have the low transaction costs or ability to react as quickly as institutional investors to new information. That said, finance scholars have shown that there's a drift in returns in the month(s) after an earnings announcement -- an upward drift for positive results, and a drift downward for negative results. Called the post-earnings announcement drift, or PEAD, it's been widely studied by academics.

© LUCAS JACKSON/Reuters/Corbis

© LUCAS JACKSON/Reuters/Corbis

It's common for firms to release results after the U.S. market closes at 4 p.m. or before it opens at 9:30 a.m. While stocks can trade after hours in the U.S. market and abroad in foreign markets, the idea is to give the market a chance to digest the information before the market opens.

Earnings season describes the period after the close of the quarter when financial results are reported to investors, regulators and the public. For firms with a fiscal year that matches the calendar year, the end of June represented the end of the second quarter. Not all firms have fiscal years that match the calendar year. For example, Apple has a fiscal year that ends in 2014 on Sept. 27.

Traditionally, Alcoa was the first company to report earnings, which it did on July 8. Industry competitors often release earnings within days of each other so investors can see how they're doing on a relative basis.

Analysts get an initial read based on the company's top line, or revenue, and bottom line, or profit. An increase in revenue without a corresponding increase in profit can be bad news. Pundits speak of whether a company is beating expectations on the top line, bottom line or both.

Companies try to avoid "negative surprises" in earnings announcements. A negative surprise can trigger a selloff in the stock as the negative information is incorporated into the stock price. A "positive surprise" can trigger a run-up in the stock price as investors incorporate the good news into the stock's price. Yahoo! finance tracks which firms' results met expectations or surprised, either above or below expectations.

Aside from the financial reporting, a company also may offer guidance on what results it expects in future quarters.

Company guidance can move markets too as investors fold this piece of information into their investing strategies in deciding how the news impacts the company's future earnings potential. In recent years, some firms have stopped providing guidance to reduce the risk of missed forecasts.

Do you buy or sell stocks based on their quarterly earnings release? If so, how's that working out for you?

Read the Bankrate feature, for more on earnings season.

Follow me on Twitter @drdonsays.

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