earnings for some companies were better than expectations/estimates but still underperformed?
Hi @Pawan_Bothra -
Thanks for attending the webinar today! Unfortunately, trying to understand the relationship between the earnings release and the earnings reaction on the impact date is very complicated. This is because there are a number of factors at play – most involve the concepts we discussed around efficient market theory.
Take a look at the table I drafted below. For example, a company has really strong earnings – good revenue, better margins that past results, etc. – but this was expected by analysts, then this is ‘No Surprise / Inline’ (vs. Expectations). Then the post-announcement return may not be as high as expected. In addition, if the pre-announcement returns were ‘upward’, then the upside movement post-announcement may be muted. If there was extreme anticipation ahead of time, there may be a downward movement after the announcement.
Another thing you need to account for market risk (this is the ‘risk-adjusted returns’ that I was referring to). For example, if the stock has a beta of 2, this means that on average, it moves 2x as much as the market index. If the index goes up 1%, this stock will go up around 2%. So, if the market happens to go down 1% on the day after the announcement, and this stock goes down 1% instead of down 2% as expected, it had a +1% risk-adjusted return.
On top of that, it is very challenging to predict the direction on the event date for a specific company. There are a few quantitative studies that seem to do well historically – including the volatility skew strategy that we discussed – but you need to perform a full back test using NSE market data (vs. the study’s US data). As discussed, you would also need to do this for a portfolio of trades rather than just trying to do it once or twice. In addition to this, you can focus on pre/post-earnings trades:
- Trade long or short volatility before earnings based on your data-backed estimates of whether you believe volatility is cheap or expensive respectively.
- Trade / invest in a portfolio of equities post-earnings based on whether or not the company had an earnings surprise (positive or negative surprise in EPS vs. expectations; not just positive or negative EPS).
Hope this helps!