Learn to trade on successfully profit announcements and surprises on earnings

The financial markets move up and down according to what people believe what each share of an investment is worth in terms of the perceived value of that stock. The price of the stock represents the value of the current assets of that company plus its future earnings. When you hold a share of stock, you are basically holding a share of the future earnings action from that company. This is the reason that earnings growth is so important to the value of a stock investment. The future profitability of companies in the market is one of the biggest driving forces for increases investment value.

OK, time for a short and sweet accounting tutorial on earnings and EPS, or earnings per share. A business will generate revenue from the amount sales that they get a certain period. That business will deduct all of the expenses related to the cost of doing business from their revenue to calculate the profit, or earnings. Those earnings are divided by the number of shares floating around in the stock market (or referred to shares outstanding). When we divide by the number of shares outstanding, we have just calculated EPS. Diluted EPS is simply earnings divided by a higher divisor that adjusts for an increase in shares outstanding from convertible investments (i.e. convertible bonds) that will make the EPS smaller.

EPS = Net Income / number of shares outstanding.

Diluted EPS = Net Income / number of shares outstanding plus potential increase in shares.

An earnings surprise is exactly what you may guess it to be. An earnings surprise is basically an announcement regarding quarterly and annual earnings to the investing markets (and the financial analysts following these companies). There are positive earnings surprises and then there are negative earnings surprises…guess which one the market likes better? You guessed it: positive earnings surprises. A positive earnings surprise is an announcement by the company’s senior management that its earnings beat the consensus analyst forecasts.
When you are going to scoop up some shares a certain stock investment, you should also think about an exit strategy in case the investment starts costing you some dough. Investors should develop their own selling rules for their own shares which guide them on how and when that investor will sell the shares that they own. Selling shares of your investment should be either to limit losses or capture gains. Selling rules that you establish will help guide you in a non-emotional fashion of when you should dump your shares.

There are some good Internet resources for finding potential investment opportunities in companies that show earnings surprises. Yahoo Finance was useful for finding the earnings surprises. Zack’s Investment Research was useful for finding the forecasted earnings growth rate for next quarter and next year. The following three ticker symbols are three examples of good investment candidates when these companies reported earnings (and subsequently earnings surprises)…