This past week has seen some of the biggest names on the stock market announce earnings results. Earnings season is in full swing, and not a moment too soon.
Better-than-expected results and record profit reports from companies such as Facebook, Procter & Gamble, and 3M have not only made headlines but boosted stock prices. The Dow Jones Industrial Average just posted the strongest gain in more than seven weeks. Investors are feeling more confident about the market and looking for momentum stocks to purchase again.
And now a study recently released by Goldman Sachs reveals how to predict if a stock will rise following its earnings report. The key: the stock's performance in the two weeks leading up to a company's earnings announcement.
The long-term study, conducted by Goldman's options team, monitored performance pre- and post-earnings results and showed that stocks that underperformed during the two weeks leading up to their announcements "tended to have stronger positive reactions on earnings day."
The reason, Goldman, explains, is that investors tend to reduce positions in the lead-up to earnings announcements. Frightened by negative media coverage prior to the event, they sell off in order to avoid anticipated risk. Upon receiving better-than-expected results, with risk alleviated, they reinvest in the same stocks. In addition, "those stocks that underperform the most ahead of earnings may have lower expectations," leading to a stronger, more positive reaction following results releases.
One of this week's biggest announcements came from Facebook. The social networking company and hot tech stock reported a better-than-expected 51.7% jump in revenue, passing $5 billion for the first time. FB shares skyrocketed following the announcement, shooting up 14.61% to $108.25 in pre-market trading. Looking at the historical data for Facebook, trading volume surged from below 20 million at the end of 2015 to more than 58 million on January 20. At the time, the stock was dipping below $90. This would appear to illustrate the Goldman Sachs analysts' theory.
The analysts conducted the survey in order to evaluate the best strategy for playing stock options around earnings seasons. They conclude that buying calls on stocks that have decreased in price in the two weeks leading up to their result announcements is the optimum tactic.
Whether or not the study's reasoning is correct, it certainly is the case that stocks leap in price following better-than-anticipated announcements. And coming on the heels of the recent market slump this early in 2016, good news has been music to the market's ears.
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This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.