From time to time, I mention that money is made if you are ahead of the market. However, this is always an intriguing question, how can one get ahead of the market? Today I am covering one of the ways to get ahead.
Fundamental Analysis (FA): In my opinion, this is probably the number one method most people use to get ahead of the market. Most think they have studied the fundamentals, know cash flows very well and understand the assumption behind earning projections to derive an intrinsic value of the company. There are many tools to derive value of a company, most popular being “discount cash flow” method and the easiest one being “market comparable” i.e. P/E, etc. However, this valuation is based on “publicly” available information and even a slight assumption variation can skew value in one direction. It requires much more than just analyzing the financial statements and industry trends and of course it is time taking. However, once done thoroughly, this, in my opinion, is surely the best way to be well ahead of the market.
Technical Analysis (TA): This is probably the 2nd most widely used method to get ahead. Predominantly there are two approaches, “Lagging indicators” and “Leading indicators”. I am not a firm believer in TA except when occasionally I use the 2nd one to help me determine “exit” and “entry” points for short-term trading opportunities. I define short-term here as the zone between “entry and exit” regardless of time and for me it’s different for stocks vs. options.
For option traders, time is very precious. What if you could get FA and TA in an easier way for short-term trading opportunity? What if you could easily derive some meaningful insights from analysts’ work?
Let me introduce “Ahead of market” to you.
But before I take you to the review of this wonderful book that can be used for both stock as well as option trading, let me share few things.
The link to amazon is not working well. You may want to buy it directly from my amazon bookstore. I shall highlight it later in OP’s reading list.
Though this book is designed to teach one how to implement several investment strategies that enable you to use research produced by wall-street stock analysts, read this book to grasp a wonderful concept thoroughly i.e. earning estimates revisions.
Here is the concept;
An analyst on wall-street covers one or more companies and he or she is paid, most cases, via investment banking business to their firm. Analysts, like other communities, tend to herd and very rarely differ from group’s opinion. Based on their “assessment” of the company and its periodic business, Analyst may revise earning estimates time to time. But he or she won’t deviate too much from the group’s opinion. Slowly other analysts who are following the same company may revise their estimates too. In general there are several types of estimates, 90days, 60days, 30days, 7days and current estimates. If you see a rising trend, it means business is doing well and expected to beat earnings. If it is a declining trend, the company is most likely to miss the estimates. That’s it!
You may want to read the book to understand thoroughly and also find more useful insights as here I am focusing on one concept only.
But how do you use this concept to make money?
I use this concept to develop an opinion about a company just before it is to announce earning results.
The big picture:
Beat Earnings + Beat revenues + Lift outlook for both = Potential gap-up and break-out
If this Q as well as this FY earning estimates are rising, there is high probability it will beat earning estimates.
If this Q, this FY, revenue estimates are rising, there is high probability it will beat revenue estimates.
If trend is rising for next Q and for next fiscal estimates, there is high probability that it will lift estimates for next quarter and next year.
Checkout estimate for Apple here (as of April 3, 2007):
Check out the chart and see the impact on price as well, isn’t someone ahead of the market already?
If we can estimates these revisions thoroughly beforehand, we know in advance what many call “Surprise”. And if we have a stock(s) that does this most of the time, we have a winner(s) in our portfolio.
Please note that though, this is not the only factor that drives stocks crazy after earnings announcement (check out my coverage of Google in last quarter part-1, part-2, part-3 etc.) there are factors too. For instance, past history of continuously beating and lifting estimates builds “expectancy” and company needs to beat this “expectancy” to drive stock crazy. Other factors include margins, free cash flow, etc.
However, this concept makes 80/20 basis for stocks movement after earnings result, and for exceptional gains in short-time, at times.
Profitable trading, OptionPundit