Surviving the Results Season Battlefield

Navigating the Risks of Results Season

A comprehensive approach to minimising risk and maximising gains.

Marcus Padley | 13 August 2024 | Education Corner

The Perils of Results Season

We are into the results season, and these days, thanks to the herd that now thunders around the market in the short term, and the computers that react to a whiff, rather than a sniff, or even a taste, the results season has become a dangerous time. 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. Results seasons have been getting progressively more dangerous for a number of reasons.

Continuous Disclosure and Its Impact

The first is continuous disclosure requirements, which mean that a company can’t quietly feed a message into the market anymore. Instead, it has to dump it. When a company hasn’t said anything to the market for six months, their results can easily surprise. Before continuous disclosure, companies would feed changing expectations into the market through select brokers. They would ‘seep’ their guidance in, not crash it in. It was called “managing expectations,” and this selective briefing method, far from being unfair, was seen as a company’s professional duty. But it is no more. Now listed companies have no choice but to dump information in, either in a pre-results confession or on the day of the results. The net result is that they aren’t managing expectations as well as they used to, making the odds of a surprise much higher than they used to be.

High-Frequency Trading and Increased Volatility

The other volatility-inducing factor during the results season is high-frequency trading (HFT). 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 one percent on the news, high-frequency trading means it moves two percent, or five percent, or ten percent. 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, a multi-billion dollar market cap company can open down 20% on the day of its results, only to bounce from the low before the end of the day. Company CEOs now get lessons on how not to phrase their announcements so as not to trigger the algorithms.

The Lag of Human Analysis

Notably, this all ‘ridiculous’ high-frequency activity happens before any analysis is done by the brokers or the big institutional fund managers. Otherwise, some sanity might prevail. But it's not possible for the big funds to do the research, revalue a company, and make their decisions between 8:30 am when the results are announced and 10:00 am when they start trading the shares. But the prices gap anyway. As if a high-profile fund manager like Fidelity, who is probably asleep in New York, or Australian Super, who are too big to do anything in the short term, has accurately researched, re-valued, and decided to sell a company down to a new level in the time between the results announcement at 8:30 am and the market open at 10:00 am. They haven’t; they can’t, but it happens.

ASIC’s Stance on High-Frequency Trading

And don’t expect this situation to change. ASIC’s study into HFT concluded that while HFT 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 has no interest in limiting it because they are making money from HFT customers paying for high-speed data feeds with terabytes of information being provided by the exchange at a huge cost.

Results Season: High-Risk Periods for Investors

The bottom line is that results seasons are now high-risk periods for investors.

How to Handle Results Season Risk

Expect the Risk

You have to expect results season risk, and if you don't like it, then this mantra may suit you: “If in doubt, get out.” If you have concerns about one of your stocks having bad results, especially if it is a mid-cap stock, is trending down into results, and is priced on sentiment rather than fundamentals, then think about selling it before results. Avoid the risk and come back later. Going into the results announcement with your fingers crossed is not a sleep-at-night strategy.

"Results Risk" Alarm Bells

Here are some of the signs that set off the “Results Risk” alarm bells:

• Trending down into results
• No recent guidance
• Has disappointed on previous results announcements
• Is operating against industry headwinds (the tide)
• 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 (Don’t bet on a resurrection)
• Is a stock on the list of most shorted stocks
• Is a stock you 'hope' has good results

Low-Risk Results Indicators

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
• They are swimming with the tide (good industry trends)
• Have been upgraded by brokers ahead of results
• Is a big well-researched stock
• Has a history of good results
• Has consistent earnings growth
• Has consistent dividend growth
• Are not on the most shorted list
• You would happily buy on weakness

Post-Results Strategy

It is much better to miss a bounce on results and buy after the company has cleared the air, than it is to step on a landmine. The market takes no prisoners these days, so caution rather than bravery will win the day. Far better you go to bed with no exposure than you go to bed worrying about some mid-cap 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.

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Some 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. There are plenty of results calendars around. Marcus Today has one.

Check the Announcement History

Go back and look at the latest earnings announcement, an AGM maybe, a trading statement. Hopefully, it was recent. If it was, the tone of these results is likely to be the same. Find out whether it was positive or not, if the share price went up or down, whether brokers upgraded the next day or not. It is unlikely a company that has seen earnings announcement running into results (good or bad) 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.

Dividend Stripping

The traditional trade is to buy big income-paying stocks some fifty days or more before the dividend ex-date. Usually, 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, 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 trend. And if the results are good, quite often, the stock will trend up after the announcement anyway.

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 five percent, 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 good 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 more risky.

The Share Price Trend Going into Results

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. Generally speaking, if a company share price trends up into the results, it suggests the results will be okay. Uptrends and downtrends ahead of results highlight stocks that the market is comfortable with (lower risk) and those it is worrying about (higher risk).

Managing Risk in Mid-Cap and Small-Cap Growth Stocks

The riskiest stocks come results season are the mid-cap and small-cap growth stocks. You really have little idea how the market will react; it can be heroic or savage, with not a lot in the middle. It’s a bit of a Lotto. You can be hit by lightning or turned instantly into a hero, through no fault of your own. If you are risk-averse, consider getting out of big holdings in smaller stocks over the results season, just to avoid risk. You can always buy back in later, even if you do miss a pop. That’s the price you pay for sleeping at night in August.

Post-Results Stock-Picking Opportunities

Then comes September. Post-results is a fantastic time to do some stock-picking. After announcing results, companies are significantly de-risked for the next three to six months because the results have filled the information gap. You can confidently believe the numbers you are working with and value companies more accurately. After the results, investment risk is at its lowest. Good luck this results season. It’s a lottery, a danger, but with a little bit of common sense, you can narrow the odds significantly.