There are times when an investor should hold onto a stock when a company has just reported solid earnings or made some other positive announcement. However, there are also times when an investor should bail the second good news hits the tape. So how can you tell when to "sell on the news"? Let's take a look at some of the instances where bailing out might be the best option.
Look for Something Offsetting
Very often, companies are aware that a particular piece of bad news will have an adverse impact on their stock price. In an effort to limit the potential damage, they combine it with a positive announcement and then disseminate it to the wire services, hoping that Wall Street will overlook it. Don't be fooled by this tactic! Read the whole release and try to read between the lines; if bad news is in there evaluate it carefully - it may signal that it's time to get out of this stock.
A terrific example of mixing bad news with good news can be found in a 2007 Crocs press release. The well-known maker of footwear released its Q3 2007 results on Oct. 31, 2007. At first blush, they appeared to be good news. The company earned 66 cents per share and beat the average consensus estimate by 3 cents per share. However, baked into that apple pie announcement was management's full-year earnings guidance, which was lower that what Wall Street had been expecting.
Long story short, the stock fell more than 35% the following day, when the investment community took notice of the disappointing forecast. In this case, there wasn't much time to dig deeper and really investigate the stock, so it made sense to bail at the first sight of good news.
How Will the News Affect the Future?
All investors should ponder what impact a spate of good news might have on the future. In other words, a company might announce that a new product is on the horizon that could potentially lead to accelerated revenue growth going forward. While this might sound attractive and entice some investors to buy the stock, the savvy investor should be thinking about what the company may have to spend in the future in order to manufacture, distribute and sell this new product. In short, what good is it if the company has to pay an exorbitant amount of money at the expense of near-term earnings to build out manufacturing capacity or the sales staff in order to sell that product - particularly if its success isn't guaranteed?
Again, using Crocs as an example, many proponents of the company in 2007 cited its new products and growth potential overseas as being a big potential driver of the stock going forward. However, what these folks failed to realize is that in order to sell its wares across the pond the company would have to build out its manufacturing and distribution capacity in a pretty big way and that this could take a toll on future earnings.
Once again, take in the good news, process it and then try to come up with any potential repercussions this might entail for the company. If serious repercussions exist, you may want to move on.
Be Aware of Expectations
Sometimes a company will report stellar earnings that far exceed the numbers it reported in both the year-ago quarter and the prior quarter. In some instances, the results may even best analyst expectations. However, if the company fails to meet the "whisper number," or some other expectations on the Street, the stock could get crushed.
The lesson here is for all investors to keep their eyes and ears open, read analyst reports, press releases and other news to try to determine what the real expectations are. That way, if the company reports what looks like a good quarter on the surface, you can bail before the general public gets wind of the fact that it fell shy of the whisper number.
Be Aware of Companies that Establish a Trend
When a company beats consensus estimates quarter after quarter, it's fun to watch the stock respond positively, especially if you are a shareholder and are making lots of money. However, investors should keep in mind that sometimes it makes sense to sell when a company has a really great quarter if for no other reason than it may be harder for the company to exceed its performance in a sequential quarter or in the same period next year.
Wall Street sometimes has unrealistic expectations that companies can grow their earnings and revenues at a break-neck clip quarter after quarter and year after year for perpetuity. Unfortunately, if a company inevitably stumbles, the investment community tends to sell the stock en masse. Learn from this and consider it the next time the company you own reports a better-than-expected quarter.
Has the Company Milked the Sell Side for All It's Worth?
When analysts pick up research coverage on a particular stock, it usually takes off. The reason for this is simple: Once the analyst writes a report, the firm's brokers start recommending the stock. In addition, the research usually gets circulated among all of the firm's clients.
However, if a company already has a large number of brokerage firms covering it and that coverage is generally upbeat, it rarely experiences such a "pop."
After good news is released, investors should ponder whether the company has the potential to garner additional positive research coverage, because this can dramatically impact money flow into the stock. If seemingly every analyst on the Street already covers the stock and has a "buy" rating on it, it may be time to seek greener pastures elsewhere.
Will the Positive Event Steer the Company Away from Its Mission or Goals?
Sometimes a company will announce the building of a new product or plant, and analysts will speculate and ratchet up their earnings models in the expectation that this news will drive financial results going forward.
But what if the new product or project only provides a temporary boost to earnings? And what happens if it actually steers the company into a business in which the company is not as proficient? Is that really good news?
Investors should ponder whether a company's news announcement is consistent with the company's goals and will enhance financial results over the long haul. If, after careful examination, the investor deems the action more of a distraction than a help, then it may be time to sell.
How Will Other Investors View the Event?
Investors should remember that their opinions on a given stock or news event are usually just one of thousands - if not millions - out there. This means that no matter how positive a news event may look to you, it's likely that other investors hold a completely opposite view. As such, investors should try to predict how the bulk of other investors might view the news and react to it.
For example, if you think that the investment community as a whole will frown upon what you perceive as good news, the stock might not be a keeper.
The Bottom Line
While it may make sense to hold onto a stock after a company makes a positive announcement, there are also instances when investors should take advantage of the good news and move on to other opportunities.