What do stocks tend to do after reporting earnings?
One might think that it depends entirely on the name; that investors reach an unstated consensus ahead of the event, and as the actual results and guidance come in, stocks rise and fall with equal frequency. But that's not what Goldman Sachs' options research desk found.
Armed with an analysis of 19 years' worth of data, Goldman found that stocks not only tend to rise off of earnings, but also beat the broader market in the process. (Tweet This)
"We estimate the average stock in our study was up 0.7 percent and outperformed the by 0.4 percent in the five days around earnings," Goldman wrote in a Wednesday note.
That may not sound like much, but the persistent use of an options strategy would have produced some quite nice gains.
"Call buying produced an average profit of 14 percent (before transaction costs) and was profitable in all 19 years," from 1996 to 2015, Goldman wrote.
To be sure, the options research team goes on to indicate that a simple strategy of buying calls on every stock ahead of earnings is not necessarily a great strategy, as the likely returns don't adequately compensate investors for the risk. Still, a trend this pronounced is crying out for an explanation.
Goldman's best guess is that after results, investors collectively tend to issue a sigh of relief, as a potentially stock-crushing event is now in the rear-view window.
"These observations appear consistent with the idea that investors reduce stock positions ahead of an event to avoid risk, and reinvest in the stock when the uncertainty of the earnings report is removed," the team wrote.
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That hunch is supported by another of Goldman's findings: The stocks that underperformed in the two weeks before reporting earnings "tended to have stronger positive reactions on earnings day."
But Larry McDonald, head of U.S. strategy with Societe Generale's macro group, has a more skeptical interpretation.
"This quarter, if you look at companies that are taking earnings guidance down versus companies that are taking earnings guidance up, you have the highest percentage of down-to-ups in six years. And we're in a bull market, and supposedly a strong economy. So something's going on where companies are lowering the bar to beat the bar, and that's what Goldman's picking up on here," McDonald said.
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