How The Earnings Report Game Works

Wall Street’s earnings game reminds me of a political scene: the politicians are all sitting at a table, lying through their teeth, realizing that everyone else is lying, and grinning from ear to ear like some demented animal. For those who aren’t familiar with why earnings reports are called “the earnings game”, here’s how it works.

Quite honestly, none of the analysts and investors covering the stock have a friggin’ clue what the report will say, so when the report is released in the morning, the market goes haywire for the first half an hour. Because the report so so damn thick, there’s a lot to digest, even for their Harvard-certified brains. That is why in the first half hour after the report is released, you’ll see the market swing back and forth, like a child who can’t chose which candy he wants to buy at the store. There’s a ton of questions that everyone’s trying to figure out, such as:

Are sales increasing? How about operating expenses? Was it a one time revenue-bringer? Why did management buy back stock?

Case in point – few understand what the hell’s going on. However, some investors who laboriously pore through years of earnings reports, find how the market reacts to certain things, and understand how the management team plays the earnings game will have a huge edge: because the market swings widly when the report hits the wires, there’ll be big market inefficiencies that savvy investors and traders can exploit.

Now the funny part that reminds me of American politics is the conference call. The management team tries to vaguely explain to the analysts how the business works, and the analysts are just nodding their heads up and down and saying “ohhhhhh, ahhhh” when in reality, they have no friggin clue what’s going on. Everyone in the room (including the analysts themselves) knows that the analysts know next to nothing, and everyone in the room (including the corporate executives themselves) know that the executives are just playing a staged rehearsal. Although this game is really pointless, it continues because ultimately, the public is going to read the analysts’ reports, which will impact the stock price.

The companies you should want to buy are the ones that are run by executives who know how to play the earnings game. Here’s how the game is properly played: underpromise, and overdeliver. If the corporate suite sets high expectations, no one’s going to be excited when the company reaches those expectations. But if they set low expectations and overachieve, the market is going to go wild with exuberance. Companies that do this, such as Apple, show that they know exactly how to mess around with the stock price.

Now here’s the part where easy money actually exists. The analysts (who all have the CEO’s home phone number on speed dial) are falling over themselves saying “way to go, Joe!” (a.k.a. that’s basically market-speak for “outlook-boost coming right up!”) Essentially, it’s pretty obvious that the stock will rise once the earnings-estimates are raised, so all you got to do is hold onto the stock, wait for the market to bid up the stock price when the earnings-outlook is raised, and sell it at a profit.