How to Use Analyst Information to Trade Wisely
Sometimes, deciphering analyst talk to decide how to trade can be difficult. In addition to what senior management is saying, you also need to listen to how they’re saying it. If management is happy with the results, they’ll probably be upbeat and talking about a rosy future for the company.
On the other hand, if management isn’t so happy with the results, the mood probably will be downbeat and apologetic as they try to explain why the company didn’t perform as expected and make excuses for their failure to meet expectations.
Learn to listen and read between the company lines. Try to listen in on every earnings call. Before that first call, you need to read analysts’ reports and become as familiar as possible with the company’s earnings history.
Whether a company is meeting its own projections and analysts’ expectations is the most important clue about how a company is doing and how the stock market will react to its periodic reports. If the company fails to meet expectations, the market will likely punish the stock by driving the price down, and that can point to a good trading opportunity.
If you believe the setback is temporary, you may want to wait for the stock to bottom out before buying it. If you think failing periodic expectations is a sign of long-term bad news, and you hold a position in the stock, you may want to sell it as soon as possible.
Listen for information that indicates whether revenue growth kept pace with earnings growth. This factor becomes even more critical whenever the economy slows down, because a company may play with or manipulate the numbers in a practice that’s known as window dressing, or making sure that earnings meet expectations. However, manipulating revenues is more difficult. Growth in revenues is the key to continued earnings growth in the future.
Although manipulating earnings may be difficult, we’ve seen companies do it successfully for at least a few quarters and, in some cases, a few years. A number of companies caught in recent Wall Street scandals successfully manipulated these numbers with creative methods of booking revenue. One account that you may want to watch for signs of revenue manipulation is accounts receivable.
If receivables rise dramatically above historical balances, one of two things are likely — the company is having a hard time collecting on its accounts or the company is booking fictitious revenue. Manipulation may also be detected when a company reports revenue for items sold that is actually greater than the company has the capacity to produce.
You may notice analysts questioning revenue-growth figures in great detail. This examination by analysts can be a sign that they may suspect problems with the numbers. Detecting any of these signs while listening to a call can be a sign of possible trouble ahead.
You can find out a great deal about how analysts are responding to a company’s report by merely listening to the tone of their questions. By listening to how analysts are asking questions and what questions they are asking, you can judge whether the analysts are downbeat on company prospects, especially if they’re asking increasingly probing questions.
On the other hand, you may notice that analysts are upbeat and encourage senior management to talk even more positively about their results and future plans. When you’ve followed the analysts’ calls for a company during several quarters, recognizing whether the mood has changed isn’t difficult. When analysts receive news positively, they often start their questions with some kind of congratulatory remark.
Be sure to jot down the names of analysts, especially the ones making positive remarks. The positive remarks from analysts with sell-side orientation may not be as good a sign as the positive remarks from buy-side analysts.
Buy-side analysts carry the most weight whenever they’re indicating a positive reaction to the company’s financial news. Many buy-side analysts who attend analyst calls already have a stake in the company, so they have a vested interest in putting a positive spin on the news.
If they’re positive, they’ll likely revise their earnings estimates upward, which can be the first indication that they’ll recommend additional buys and the stock may be getting ready to enter an upward trend. This positive spin can give you the first sign of a good trading opportunity, so watch your technical analysis for any signals of a potential breakout.
Just the facts
The best way to judge whether senior managers are confident in their reporting is determining how quickly they respond to questions. If senior managers are confident with their numbers, they respond to questions quickly, taking little time to think their responses through.
If senior managers are unsure of their reports, they’re more likely to take a good deal of time checking through their papers to answer even the simplest questions. You definitely need to think twice about buying or holding stock in a company whose management shows a lack of confidence in reporting their numbers.
You’re likely to get a good reading about how senior managers view the company’s future prospects by listening to their vision for the company and whether the results actually demonstrate that they are fulfilling that vision. When managers are successfully fulfilling their vision, they clearly articulate their view of the company’s future and how they plan to get there.
Ask yourself whether management inspires you with its vision. If not, managers most likely are not inspiring their employees, which can be an early sign that the company is heading on a downward trend.
Happy employees are a good sign that a company will be able to meet its future expectations. If, during the call, you hear that the company is having trouble attracting new employees or retaining its existing staff, you may be looking at a sign of trouble on the horizon. High employee turnover is bad for future growth.