We are into the results season and these days, for equity investors, the results month is like being on a battlefield during an artillery barrage wearing fluoro orange. You never quite know when you’re going to get blown up.
In the last results season this time last year, 51 per cent of the two hundred and sixty major results saw their share prices move more than 3 per cent on the day of their results. 35 per cent moved more than 5 per cent and 11 per cent moved by 10 per cent. In other words, you had a one in 10 chance of your stock moving 10 per cent on results. That is a very unpleasant prospect for a “Leave me alone. I just want 6 per cent” retiree investor.
Why Results Have Become Dangerous
This relatively new and accelerating results season volatility is a function of two things. The first is continuous disclosure requirements which mean a company can’t feed a message into the market anymore. Instead, it has to dump it. Some companies often haven’t said anything to the market for six months, so results can easily surprise. Before rigorous continuous disclosure requirements, companies would feed changing expectations into the market through select brokers, and it would 'seep' in, not crash in. It was called “managing expectations” and this selective briefing method, far from being unfair, was seen as a company’s professional duty. No more.
The other volatility-inducing factor is high-frequency trading. High-frequency trading identifies and accelerates market activity, exaggerates it, and when it comes to the results season, if a stock was going to move 1 per cent on the news, high-frequency trading means it moves 2 per cent, or 5 per cent, or 10 per cent.
The vanilla algorithms run by high-frequency traders are designed to detect other people’s orders moving in and out of the screen, even before they are executed. They also respond to executed trades and in so doing detect short-term price trends, in nanoseconds, and respond to them by placing their own orders in nanoseconds without any consideration for fundamentals.
The algorithms are also now electronically scanning the words of results announcements, no humans involved, and are picking up on adjectives and phrases like "profit warning" and "lowered guidance" or "raised guidance". And they instantaneously start placing orders in response.
That algorithm activity is then picked up by the vanilla activity matching algorithms, and on the back of all that, last year we saw WorleyParsons open down 21.8 per cent on the day of its results, only to bounce 11.5 per cent from the low before the end of the day.
Notably, this all happens before any analysis is done by the brokers or the big institutional fund managers. And don't expect this situation to change, ASIC's study into HFT concluded that while it may be exaggerating short-term price movements, HFT was not disrupting the integrity of the market or materially raising the costs of execution enough to ban it. It is here to stay, and the ASX have no interest in limiting it either because they are raking it in from HFT customers paying for high-speed data feeds with terabytes of information being provided by the exchange at a huge cost.
The bottom line is that Results and AGM seasons are now high-risk periods for investors.
Adapting to Results Risk
Running the Marcus Today SMA, I have had to adapt to results risk and have done so using this mantra - “If in doubt, get out”. If I have any concerns about one of my stocks having bad results I avoid them. Alarm bells would be ringing if the stock:
- Is trending down.
- Hasn’t put out any guidance recently.
- Has disappointed with their last results.
- Is operating against industry headwinds.
- Has been downgraded by brokers ahead of results.
- Is a volatile stock.
- Is a smaller/mid-cap stock.
- Has liquidity issues (will move a lot on a surprise).
- Is a popular trading stock.
- Is a “disaster” stock (have been dumped in the last year…like AMP).
Spotting stocks with low-risk results is the opposite. They are stocks that:
- Are trending up into results.
- Have recently put out guidance (de-risked).
- The share price rose on their last results/guidance/trading update.
- Are swimming with the tide (good industry trends – the currency is a good tide – it has fallen in the last six months which is good news for a string of Australian stocks).
- Have been upgraded by brokers ahead of results (like ANN this week).
- Is a big well-researched stock.
- Has a history of good results.
- Has consistent earnings growth.
- Has consistent dividend growth.
It is much better to miss a bounce on results and buy later than it is to step on a landmine. No company is safe; the current markets take no prisoners, caution rather than bravery will win on average in the next month. Far better you go to bed with no exposure than you go to bed worrying about some mid-cap’s results the next day. After the results are out, that’s the time to jump on board, when the stock is de-risked for the next 3 to 6 months. Many uptrends will start the day of the results. And downtrends.
Playing the Odds
During the results season, we run a sweep in the office to see who can guess which company will have the best results the next day. Five dollars in and the pot goes to the person who guessed the stock that had the biggest percentage rise the next day, having announced results.
It is interesting to see which approach works. The experience is that the big punters betting on outsiders, as with sports betting, get cleaned up over the long and retire hurt after being hit up for five dollars day after day after day after constantly picking the long odds small crap company.
For an investor, there are two or three games to play during the results season. They include:
- Buying stocks in the hope they have good results.
- Avoiding stocks that could have bad results.
- Or…Buying stocks after the results.
Buying stocks after the results is the risk-free approach that makes the most sense for conservative investors. Rather than bet on results, it is far better you take a low-risk trade buying stocks after good results. Ride the wave that is created by the results rather than attempt to catch the wave before it forms. There is still a ride to be had even if you don’t catch the start.
For those of you who want to exploit this time rather than avoid it, there are ways to improve the odds of holding the right stocks and avoiding the wrong stocks over results. I have developed a list of survival techniques which, if you have the time, you should think about now before the results start coming out over the next month.
Results Survival Techniques
- Basic Vigilance. Find out when results are due for the stocks you are holding/trading. If you find a stock you hold is down 10% one morning after announcing results you didn’t know were due, it is a bit negligent. Find out when your company results are due.
- Check the announcement history. The most profitable game if you can get it right is to guess which stocks are likely to surprise on the upside. They are often the companies that have surprised on the upside before, that have jumped on previous results or have recently had a positive earnings update. Go back and look at the last earnings announcement, the AGM maybe, a trading statement and see if the share price went up or down, whether it was positive or not, whether brokers upgraded the next day or not. It is unlikely a company that has seen earnings upgrades running into results is going to disappoint, and there is an even better chance they will not disappoint. So check the recent announcement history.
- Avoid the bad ones. More than half the game these days is avoiding the disasters. Don't bet on the unlikely, on resurrection, on a falling stock. Don't swim against the tide. It’s not clever; it’s dumb. It’s a game of odds, not heroics.
- The share price trend is rarely wrong. Another very plain indicator of whether a stock is likely to surprise on the upside or downside is to look at the share price trend running into the results. The market is rarely wrong. Good stocks tend to do good things, and bad stocks tend to do bad things, and the results announcements are unlikely to turn the current trend on a sixpence. The low odds bet is to believe the current share price trend.
- Dividend stripping. The traditional trade is to buy big income-paying stocks like the banks and Telstra some 50 days or more before the dividend ex-date. This allows income chasing investors to sell on the day it goes ex-dividend and still qualify for the franking under the 45-day rule. One broker published a chart last year showing that income stocks tend to outperform in the 50 to 70 days before the ex-dividend date suggesting you buy 50+ days out from the dividend and catch the statistically typical run to the results and the dividend. I have another technique, which is to wait for the results from the CBA or Telstra, and if they are any good to you can still buy the stock before the dividend in full possession of all the facts and catch the next 45 days rather than gamble on the pre-results. If the results are good quite often, the stock will trend up after the announcement as well.
- Buy the bounces. Sell the shock drops. There is an academic study about shock drops and shock rises in share prices. The conclusion was that when it comes to shares, a stock that has a shock move up or down continues to move in that same direction for the next nine days. In other words, if a stock has a good set of results and pops up 5%, don't say "I've missed it" just buy it because it is likely to keep going in that direction for a while. Sharp moves tend to start trends not end them, presumably because after a company announces good results, sentiment improves, not for a day but for a while. The research the next day will be upbeat. Brokers will raise target prices and recommendations over the next week; it takes a while for news to be discounted. In other words, there is money to be made buying stocks after the results even if they have popped. You may miss the first day and the best day, but you'll catch the next few days of the trend, and your risk is much lower than punting ahead of the results.
- Check the numbers. Fundamentals are an obvious starting point for ranking stocks on potential risk. Broadly speaking companies with consistent earnings and high regular return on equity are more likely to produce good/ low-risk results. The bigger well-researched companies with higher yields and regular/consistent (rather than high) ROE trends are the safest. The mid-cap/small-cap growth stocks and recovery stocks with no yield, high PEs, weak balance sheets, possibly loss-making concept stocks, are riskier.
- The share price trend going into results. One very good gauge of risk is the share price trend into results. Generally speaking, it is a good indicator if a company share price trends up into the results – it suggests the results will be okay. Of course, it is also a sign that expectations are pretty high, so it can cut both ways. But on the basis that the market is usually right, this does highlight stocks that the market is comfortable with (lower risk) and those it is worrying about (higher risk).
When there is only five dollars at stake, you can afford to take a risk or two. When you’re in the share market with real money, the game is to avoid the results risk not try and exploit it by guessing.
Hopefully, this gives you an idea about how to spot that risk. Only the traders will try and make money out of it.