Earnings Surprise Definition & Trading Strategy
Earnings Surprise Definition
An earnings surprise occurs when a company's quarterly or annual report is above or below analysts' earnings estimates. There is no set number which constitutes a earnings surprise, other than it is not within the expected consensus estimate. Many times this surprise will lead to a sharp reaction in the stock. This reaction in the stock is also dependent upon how closely the stock is followed by analysts and the public at large. Like anything else in business, the number of active participants will lead to more volume and potentially larger price swings.
Interpreting Earnings Surprises
Many novice traders will attempt to trade a stock simply based on the earnings announcement. When a company reports its earnings, there are always a group of speculators who purchase the stock on the news, only to see the issue plummet 15 minutes after the announcement. Conversely, there are times where a company will miss earnings but the stock will rise. So why does this happen? The reality of it is that the earnings number is just that, a number. The market will interpret not only the number but potential earnings forecast and guidance when assessing the value of a stock.
How to Trade Earnings Surprises
The last thing an investor wants to do is chase a stock after an earnings announcement. These sharp moves are often brief and lead to a market correction. Conversely, if an investor purchases a stock on the expectation that the company will beat earnings is just another form of gambling. It is best to see how the stock reacts from the earnings announcement over the following weeks. This allows all of the hysteria to leave the market and can provide a more stable market environment from which to evaluate the stock.