When large corporations report earnings, it becomes a popular parlor game to try and guess whether the business of choice grew faster or slower than Wall Street analysts expected during the previous quarter. It offers an occasion for stocks to rise and fall by 3-8% in a single day and that is usually the short-term threshold that catches the attention of investors.
What, then, do I consider to be the ideal position of strength during earnings season?
I think the ultimate objective is to already own a stock that is reasonably valued going into earnings season with liquid cash available to act upon the possibility of opportunity.
Imagine if you already owned a few hundred or thousand shares of Nike going into its earnings report yesterday. Before you know what happens, you are prepared to respond to anything.
If the stock reports earnings that greatly disappoint expectations, you have the cash available to act intelligently upon the situation that presents itself. Wall Street analysts were expecting $0.43 per share. If they came in at $0.35 and the stock fell 10%, you would have that fresh capital available to take advantage during the stock’s move from fair price to cheap.
If earnings perform largely in line with expectations, you’re fine. The stock can continue to compound undisturbed, and you still have the capital available to make a new investment.
And if the stock greatly exceeds expectations and shoots up 5-10%? Then you can see your pre-existing shares rise in value and your available capital can remain ready to exploit a far off opportunity or turn towards other attractive blue-chip stocks like Diageo (DEO).
This is not a concept for which I can claim original credit. It is exactly how Warren Buffett arranged Berkshire Hathaway during the late 1980s and early 1990s. He had enough invested such that the rising market of the mid 1980s and then the rising market of the 1990s turned the seeds he planted in the 1970s into full grown trees. But he simultaneously had stockpiled enough dividends from the likes of RJ Reynolds that he was able to load up on Coca-Cola (KO) during the declines of 1987 and then purchase a substantial block of Wells Fargo (WFC) stock during the savings and loan crisis of 1991. He repeated this strategy in a nearly identical manner with Wells Fargo stock during the financial crisis of 2008 and 2009.
For those who have already accumulated a substantial amount of assets, now might be a good time to let some cash payouts pile up and await a greener pasture ahead. For those who are aggressively building their holdings, fear not! It remains true that you only need to find one attractively valued stock at a time. I can’t see how you’d regret paying $104 for shares of Diageo right now. Relatively speaking, now is probably a good time to take up the study of valuing British stocks as they offer more attractive valuations than their similarly situated American counterparts. Based on personal circumstances, the investor loading up on British stocks and the investor letting cash build up can both be responding to the current investment climate intelligently.
Originally posted 2016-12-21 14:00:28.