Market March Madness: 1/27/14

I am going to spend more time giving quick market updates, explanations and opinions. I will continue to post my positions but I want to give a little bit more information instead of giving information without laying the foundation.

Lets get into it.

There are 2 important topics going into this week: I'll explain 1 today and the other tomorrow

1. Earnings
2. The Fed Meeting ( I'm saving the explanation for Tuesday)

 

Earnings: The Market's March Madness

In light of Warren Buffet offering 1 BILLION dollars for the most accurate March Madness Bracket, I decided to use the tourney to loosely describe earnings. 

Regular Season: 

Earnings, which are released every quarter, draw a lot of attention because they indicate how profitable a company was during the previous quarter. Investor's pay close attention to earnings because they help paint a picture of  companies' current performance and the outlook for  the future. 

Think of it like this: Investors have been using various pieces of news throughout the quarter to gauge how the company is performing.  During the regular season you watch your teams the games and keep track of their record. The season record gives an idea of what can be expected going into the tournament. 

Filling out the Bracket:

Before earnings are released investors will start to take positions (buying or selling shares/options). Their positions reflect their opinion on earnings data.

• Bullish : Buy into the stock before the earnings release in anticipation of a rally (large increase) and sell once it has hit the price you expected (collecting profits)
• Bearish: Sell the stock in anticipation that the price will go down 
• This is only profitable if your short selling, if the stock is in your portfolio, a sell would be to protect downside losses

Taking a position is similar to filling out your bracket. When filling out a bracket you consider  the teams record (previous earnings/info), the coach (CEO), industry (conference) and products/services (star players). Gathering all that info you are forecasting essentially who is going to lose and win. 

The Championship:

Okay fast forward through all the individual games and let's focus on the championship. For earnings, it is the same as their release.

 

The information people usually receive first is if the company beat or missed their earnings. Beating estimates (winning) and missing estimates (losing). The impact of the actual earnings will be reflected in how much the stock gains or loses. 

• Beating estimates will usually cause the stock price to increase because it indicates that the companies had more revenue than anticipated.
• Missing estimates will usually cause the stock price to decrease

Unlike winning and losing, the amount in which the stock moves in either direction is priced in by the reason the earnings were missed or beaten. Here are some examples of price reactions to earnings:

• Company beats earnings because they fired a bunch of people, that is not considered a sustaining source of revenue growth, so the price decreases
• Company missed earnings because they were hit with a one time legal settlement but has strong fundamentals, price decrease is not as big
• JP Morgan (JPM) is considered a stable bank with the necessary tools to continue growth and maintain strength. A couple weeks ago, JPM missed estimates. JPM's miss was largely attributed to the number of legal settlements it faced during the quarter. This event is not something an investor would see as a fundamental issue, therefore the stock barely dropped.  

• Company beats earnings because they saw a huge increase in advertising, which increased their profitability. This positive outlook will cause the price to go up. 
• Microsoft's ad revenues increased by 34% which caused their stock price to increase 
• Company misses earnings because they are terrible and have no sales and a very bleak outlook. Price goes down.

These are just a few various way earnings can be digested.

So to keep with the March Madness theme, say you expect earnings to beat estimates and you buy in early. The earnings are released and you were correct and the price soars. Just like picking the winning team in March Madness. Woohooo! 

 It isn't as black and white  as March Madness but hopefully I brought some clarity.

Today all eyes are on Apple, which should be reporting earnings shortly.

 

Best,

 

Brit

GLOSSARY

Bearish: Expect prices to decrease, also known as being "short" 

Bullish: Expect prices to increase, also known as being "long"

Profit Margins: The proportion of sales that are kept for revenue, 20% profit margin means for every dollar in sales $.20 are kept for profits. (investopedia)

Quarter: Three month time period, at the end of each quarter companies pay dividends and report earnings (investopedia)

Revenue: The amount of money a company receives from sales, investments etc. (Investopedia)