The 4 Rules of Earnings Season, Plus Tips: Buy Under Armour Next Week, Dump Amazon A.S.A.P.

"Every battle is won before it's ever fought." -- Sun Tzu

NEW YORK (TheStreet) -- The hyper-active and borderline desperate Twitter (TWTR) feeds for Under Armour (UA) and Amazon (AMZN) illustrate the gap between what many shareholders think is a positive earnings report and what actually is.

Immediately after reporting earnings on Thursday, shares in Under Armour, Amazon and Microsoft (MSFT) popped higher, but only Microsoft continued higher. All three increased revenue. From an operational point of view, they all executed extremely well. But their performance diverged.

Let's examine the differences and how investors can empower their portfolios with other holdings and profit from future earnings releases.

The first rule of earnings season is to never chase a stock unless you're taking a stop loss. If your trading desk doesn't include a Bloomberg terminal or another equally fast wire subscription in unison with computer-directed trading, you're fighting a losing battle.

MSFT Revenue (Quarterly) Chart

The second rule is that only the uninformed focus exclusively on if the company beat or missed earnings expectations. Earnings results are just that, results that report what happened BEFORE. But the market focuses on what WILL happen. Big-money Wall Street fund managers -- the whales that move a stock price -- review last quarter's results only up to the point the data aids in predicting future expectations.

While many are satisfied if Under Armour, Amazon and Microsoft outperform their previous quarter, fund managers closely scrutinize margin trends, forward guidance, growth rates (or lack thereof), competitive influences, management changes, cash flow, dilution and other factors. They are painting a picture of the next quarter, the next year and beyond.

The third rule is that one quarter doesn't matter. That's a hard one for many to understand in the heat of battle. Patterns can't be found in sample sizes of one. Fund managers plug a given company's results into spreadsheets and compare the results with previous quarters to find hidden patterns and trends.

"Every battle is won before it's ever fought," said Sun Tzu, and we all know it. But do we live it?

Are you reading the SEC filings and taking the time to understand what's happening below the surface level? Keep in mind that a company and its stock are two decidedly different things. For example, Under Armour and Amazon increased revenue, demonstrating strong demand for their offerings, and yet the stock fell.

For investors, it's more pertinent to understand the stock than the company. It may appear counter-intuitive at first, but investment decisions should focus on the stock first and company second. Understanding the stock requires a full comprehension of the company filings.

Reading Qs and Ks (quarterly and annual reports) may be an insomnia cure for people who don't respond to strong medication -- a hat tip to Robin Williams -- but they're gold mines of information. Anyone can read the reports. But understanding what to look for, and how to read past a presentation that is sometimes more useful to management goals than investors, separates those in the know and others playing a guessing game.

If you want to know what to look for, I suggest picking up Wiley's Financial Statement Analysis: A Practitioner's Guide, by Martin Fridson and Fernando Alvarez. It's a great read for non-finance majors. Plus it will be worth its weight in gold the first time and every time it helps you find information buried within an earnings report.

The fourth rule, and this one is broken on a daily basis for reasons I don't understand, is that if it's common knowledge, it's priced in and doesn't matter. Using Amazon for even one moment, everyone knows that the company has an advantage over small bookstores. Amazon has invested heavily into its logistics system and is able to move books and other products from supplier to your home at a lower cost than most others can.

Every bit of public information is already priced into the stock. Unless you know something almost everyone else doesn't, the information isn't valuable. In fact, relying on common information is often detrimental. Under Armour's earnings release demonstrated enormous growth, but everyone and their brother already expected it.

As a result, when the company didn't crush the already mile-high expectations, the stock quickly sold off, causing an avalanche of sellers rushing for the exits. As an independent investor, your greatest advantage is focusing on industries you already know about. If you're in the sportswear industry and can see trends before they show up on analysts' spreadsheets, you have an edge over money managers.

I don't mean inside information that regulations prohibit insiders from trading on. If you work in a medical office and notice a new product or an improvement to an old product that you like and others like, it's probably worth your time to investigate the company that produces it.

Now let's go full circle and examine the chart patterns for our three earnings-related stocks.

If you're stuck in Under Armour, I think your prospects are much brighter than with Amazon. But don't expect the price decline to bottom before Monday. It normally takes two or three days for an earnings disappointment similar to Under Armour's to become fully discounted. The sweet spot to buy on the dip is late Monday or Tuesday for a more conservative entry.

Amazon's problem is it doesn't generate a return on investment. I've written many articles about the perils of buying momentum stocks lacking a meaningful return on investment. The only thing keeping the shares above $200 right now is a belief that someday it will monetize its revenue. Everyone worth their salt knows that it's easy to generate lots of revenue in retail if you're willing to sell at the lowest cost. But the moment a retailer tries to increase margins, sales fall off a cliff.

I suggest taking advantage of up days as an opportunity to scale back or exit.

At the time of publication, Weinstein had no positions in any of the securities mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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