Avoid Earnings Reports like the plague! That’s what I promote in my book and DVD Series, Cashing in on Covered Calls. I stand by that premise for many reasons, the most important is the one that relates to the great returns I have been getting. But ERs do give us information regarding the overall economy, industires, and individual stocks we may want to add to our watchlist.
We are now well into the current earnings season and the results thus far are much better than analysts anticipated (holy cow, analysts can be wrong!). Pardon the Phil Rizzuto moment.
Overall, for the 2nd quarter, the earnings growth for the S&P 500 was -17.8%. On first glance, this does not look very positive but let’s examine the numbers a little closer. There are two extreme numbers incorporated into the -17.8% figure. First we have a very positive energy earnings growth of +26.4% for ENERGY. On the other end of the spectrum, we have an extremely negative EG of -85.3% for FINANCIALS and -23.9% for CONSUMER DISCRETIONARIES. Financials, as horrific as these earnings appear, are actually starting to show some stability.
Now, if we strip out the financials, the S&P earnings growth is actually up about 9%. If we eliminate both extremes, financials and energy, the S&P earnings growth is still up about 5%. Admittedly, this is below the average of 8% for the 2nd quarter but certainly not reason to panic.
Let’s look at the overall Earnings Report Card going from worst to best:
Consumer Discretionary- -23.9%
Consumer Staples- +4.9%
Health care- +8.3%
Ashwani Kaul, the Senior Marketing Analyst for Thomson Reuters is a well-regarded analyst relating to earnings and market conditions. “The numbers as a whole point to a pretty good earnings season”. He pointed out that the current earnings recession has lasted only 3 quarters compared to the one we experienced from 2001 to 2003. His firm, Thomson Reuter is looking for excellent earnings over the next 3 to 4 quarters with PE (price to earnings) multiples in the 12.5 area. More specifically, they are estimating EG for the 3rd quarter to be about 11.5%, 60% for the 4th quarter, and 22% for 2009. This bodes well for the stock market. Of course, there are no guarantees but put earnings in the asset column for stocks at this time.
When ERs are announced, they are compared to analysts expectations. This produces some surprises, both positive and negative. The scorecard on this front is a plus as well:
Positive surprises: 72.2% as compared to 69.9% in the 1st quarter.
Negative surprises: 23% compared to 26.7% in the 1st quarter.
Besides painting a positive earnings picture for the stock market, this information can also give us another reason to add a stock to our watchlist. For example, if a stock has a positive earnings surprise AND meets our system criteria, it should attract our interest. I’ve done some research and generated a list of some stocks that meet both requirements. Here they are along with the percentage of positive earnings surprise for the current quarter:
Last Week’s Economic News:
The economy is still striving to recover but is only enjoying minimal success. Consumer spending remains restricted due to rising food and gasoline prices. Tighter credit requirements are stiffling sales of new and exisiting homes. The one bright spot this week came from durable-goods manufacturers, which reported an unexpected increase in demand. This is a sign that companies are willing to invest in capital equipment despite the adversity in the financial markets this year. For the week, the S&P 500 declined -0.2% to 1258 for a year-to-date return of -13.4%. This is about 20% below the returns we would anticipate in an average stock market year.
The favorable picture painted by the ERs this earnings season belie the negativity so many of the experts have expressed about the resiliency of our economy. These reports , in my view, are foreshadowing an improvement in our economy which should turn into cash for us in the near future. For more information on Earnings Reports see pages 129-140 in my book, Cashing in on Covered Calls; Advanced Seminar II in my DVD and CD Series; and pages 83-92 in the Companion Workbook.
****Please Note: The ER dates listed in the free websites I present in my material may NOT be 100% accurate. Oftentimes companies announce an ER date and then change it as that date approaches. The alteration is not dramatic but can push the announcement from one contract period to another. The point is that an ER confirmation, by rechecking these sites prior to purchasing a stock or selling the option, is a good idea. This also applies to the ER date located in the IBD 100 charts as Bob pointed out in the comments link of my previous journal article.
I hope you find this information useful and look foward to hearing your comments and suggestions.
Alan, my compliments and appreciation on what I consider to be a very well written book and thought out investing discipline. A question I have is how do you manage bear markets, when the overall market trend is ugly especially in the first two weeks of the options contract period – kind of like things lately? I know selling ITM options gives downside protection – are you always going in every month or are there times when you prefer to sit it out…and wait for things to reverse?
Thank you for your kind words.
I have been selling cc options for 10 years now and have experienced “ugly” months like these before. This market is particularly challenging due to the sub-prime dilemma and rising gas and food prices.
Market psychology is starting to pile on in a negative way. I wish I had the ability to predict which months will be up and those that will be down. I don’t and have yet to find anyone who does. So my game plan is to stay in the market until such time that I can identify a “plummeting, long-term bear market”. I don’t believe that is where we are now for many of the reasons I mentioned in the above article.
So, I sell ITM or deep ITM options. There are times I will increase my system requirements such as elevating the Scouter requirement from 5 to 7 or elevate the Industry technical rating to a B from a C. When I do this, I expand my watchlist from the 40-60 number (I speak of in my system) to 70 or higher. This is because of the stricter requirements will generate fewer stocks eligible for purchase that month.
Of all the changes though, the most important in my view is what you mentioned in your question and that is to sell ITM calls and avoid the riskier at-the-money or out-of-the-money.
If you can survive current market conditions and manage your portfolio through the bad times, you can be in for some serious profits when the market turns around.
Here’s an example of letting an ER pass early in the contract period and then selling the option:
WLT was up over $12 per share today. The ER was released after the market closed yesterday.
You could buy the stock for $99.26 per share and sell the out-of-the-money 8/100 for $630 per contract generating better than a 6% 3-week return. Cautious investors would sell the in-the-money 8/95 @ $900 per contract. We deduct the $426 intrinsic value and collect a neat $474 profit per contract, nearly a 5% 3-week return with significant downside protection.
There are many opportunities similiar to this one. All we need to do is keep our eyes and ears open.
Alan, I am really confused now. How did WLT ever come on a watch list. It doesn’t meet the parameters of the IBD scan for safe stocks. I saw that it was up over 6.00 again today. Do you have a watch list of stocks with earnings that are coming up. I noticed that on my TC2000 charts that it was great for 6 months until July1st Maybe I can set up a scan to find such stocks in the future Thanks Bob
I’ve written about WLT several times in the past. It’s a stock that met our system criteria in the past but currently DOES NOT (fundamentals and Scouter falls short). Recently, I suggested keeping an eye on this one waiting for the criteria to boost it back onto our watchlists. It may happen after this most recent earnings report. In doing so, I noticed this GLARING example of a stock that if you didn’t sell the option and owned the stock, you could have benefited the $12 per share. Then selling the option after the ER, another 5-6%. After today, another $6 of downside protection. I should have reiterated that the stock does not quite meet our system criteria and this is just an example of negotiating around an ER and NOT a recommendation based on the system. . I would still keep a close eye on this one. Sorry for the confusion.
The New York Stock Exchange has finalized arrangements with Google to access real time quotes at no charge. Most other sites give quotes that are 15-20 minutes delayed. Here is the link: