Don't Feed the Earnings Sharks

 | Apr 08, 2013 | 3:30 PM EDT
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It is that silliest of seasons. I am not talking about baseball season, which has had the fascinating twists and turns of the first week, but earnings season.

Starting with Alcoa (AA) this afternoon, everyone will be estimating and calculating the likely results from most of the nation's publicly traded corporations. The more aggressive among us will place trades based on what they consider to be their carefully calculated estimate and the likelihood of a substantial difference from the analysts' estimates. Most will not admit it, but they are trading more on a guess and a hope than anything else.

An awful lot of money gets lost by individual part-time traders during earnings season. I have heard pretty much every theory ever advanced on trading earnings, and none of them has worked particularly well.

When you trade earnings season, you are trading against two classifications of traders. One set is the super-experienced discretionary trader who has been doing this for a decade or two and has not only seen it all but figured out how to trade it profitably. The other is group of experts who have enough degrees to fill out a compass and enough computing power to crack the da Vinci code. Odds are that those placing a trade on their lunch hour while juggling payroll and a sick kid at home are not going to beat either of them.

I learned long ago not to invest or trade where I do not have a substantial and exploitable edge. I have made enough donations to the floor traders' retirement fund as well as the geek-and-Greek-trading lunch tab that I gave up trying to beat those guys at their game long ago. They are highly trained sharks, and I am food. This is especially true during earnings season, when prices and volatilities move quickly and complicate options pricing. I cannot beat them at their game on their field, so I do not even try anymore.

My time frame is years, not weeks or months, so I have learned to look at earnings season differently. I am going to try to position myself to react to what actually happens rather than predict what might happen. Coming into earnings season after a strong up move in the stock market as we have seen in the past year, I am hoping for a slew of earnings disappointments. That would bring the market down and create bargains. Among the banks in particular, I have dozens of stocks between 1x and 1.25x tangible book value that I would love to see miss earnings and fall precipitously in the short run. However, I will not act until they do miss and fall.

I am watching stocks such as WPX Energy (WPX) during the earnings season. Most of the company's production is natural gas, and this has depressed earnings since WPX was spun out of Williams Companies (WMB). WPX has not come anywhere close to hitting analysts' estimates in the past year, and each miss has created another round of selling. There is some risk of further government intervention in the operations of its 69%-owned holding APGO, and that has concerned investors as well. I am a long-term fan of the stock and will be watching to see if another natural-gas-fueled earnings shortfall creates an opportunity to add to my stake in the company.

BankFinancial (BFIN) has missed earnings the past two quarters, and I am really hoping that it misses again and that short-sighted investors dump the shares as a result. The Illinois bank is trading right at tangible book value, and I would love to buy a little more stock at a discount to its asset value. The same holds true for Northeast Bancorp (NBN), which trades at 90% of tangible book and would be a great addition on an earnings selloff. I am hopeful that most short-term-minded market participants remain focused on earnings instead of the far more important asset value, allowing me to continue adding to my Trade of the Decade bank stocks.

Earnings-season trading may create some interesting water-cooler conversation, but I am skeptical that it can create meaningful profits for part-time traders. Even if you are a great trader in your spare time, trading the earnings reports is like a very good high school team suiting up to play the Green Bay Packers. You may get off a great play or two, but on balance you will get beaten up and lose the game.

I prefer to allow short-term distortions to create long term opportunities and react to what the market give me. Predicting the unpredictable has just not been a profitable endeavor for me over the years.



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