Why Earnings Just Don’t Make Sense (Part 5)

Reports on Google’s 2013 Q4 earnings announcement left me utterly confused. This is the main reason I wonder whether earnings are another case of optionScam.com.

A whole sub-industry has been made out of providing earnings data, using fundamental analysis to calculate price projections, and determining what stocks to buy and sell based on those fundamentals (earnings). Ultimately, if fundamental parameters are not objectively quantifiable (i.e. no consensus!) then who is providing the right data? Surely we should be using the right data to make accurate stock picks, right?

Aside from the whole issue of data accuracy, I am not even certain any statistically significant correlation between earnings results and subsequent stock price movement exists. Certainly the people at Tasty Trade don’t. I have not replicated their backtesting results but what they have presented suggests stock price to be somewhat correlated with direction of the overall market. They actually claim the distribution of directional moves to be pretty much random +/- a bit of positive drift. That would be about 53% up and 47% down, which is consistent with overall market movement.

It would be very difficult to perform a comprehensive analysis of post-earnings stock price changes stratified by good/bad earnings results. The biggest challenge would probably be determining consensus as to whether the results are good or bad. What estimates should be used? How do we define consensus? Should we look at earnings? Revenue? Something else? Do we factor in a margin of error?

As mentioned above, looking at the post-earnings price changes independent of any estimates makes a decent argument for “randomness” despite a limited number of tickers studied.

Let’s review:

1) Many companies specialize in selling information about earnings estimates and earnings analysis.
2) Data are now available to suggest nothing about earnings may actually be predictive of subsequent stock price changes.
3) The sub-industry described in 1) makes lots of money at the expense of investors who don’t know or understand 2).

That’s a pretty good formula for optionScam.com, folks!