Earnings season can lead to large swings in individual stocks and the broader market as investors digest new financials and guidance. This time around, the market is also processing key Federal Reserve announcements, gross domestic product (GDP) data, and a slew of other macroeconomic updates. Chances are, a stock you follow has seen or could see a big move up or down.
Here's what to do if that big swing happens, as well as steps you can take to remain calm instead of letting the price action skew your perception of the company's long-term investment thesis.
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1. Bridge the gap between expectations and reality
Often, big swings in a stock's price have to do with a disconnect between analysts' expectations and the actual results or guidance. For example, the sell-off of Walmart (WMT) and Target (TGT 0.80%) stocks that began in May was due to the unexpected impact of inflation on margins, revenue growth that has failed to offset higher costs, supply chain issues, and high levels of inventory that leave both companies with too much product that consumers aren't buying right now.
2. Zoom out and focus on the big picture
In this case, expectations were not prepared for the reality, so both stocks sold off big. And while Walmart and Target may have deserved to fall, they could also be worth buying because their challenges seem to be short-term problems rather than intrinsic issues.
Supply chain disruptions throughout the pandemic led to longer lead times, which pressured Walmart and Target to stock up on inventory. The strategy worked well in 2020 and 2021 but backfired in 2022. Again, this dynamic is more of a result of what's happening in the current global economy. It doesn't have to do with either company losing market share or failing at e-commerce.
3. Consider the earnings within the context of your long-term investment thesis
Walmart and Target's price declines may not have to do with the long-term investment thesis. But sometimes, big swings to the downside are indicative of a more serious problem.
In the case of Snap (SNAP 21.75%), which has suffered brutal sell-off after sell-off and is down nearly 90% from its all-time high, the company has failed to consistently monetize its platform and directly competes with other social media companies as well as internet content providers. High stock-based compensation and ongoing net losses are red flags.
Even after selling off, Snap is still a $16 billion company. It needs to gain its footing and prove it has a viable business model. In this vein, its struggles amid the current economic climate seem to accentuate its flaws rather than be a one-off issue.
4. Listen to management's tone on the conference call
When stocks make big moves, curious investors typically want to understand everything they can. With that in mind, try listening to a recording of the earnings call instead of just reading the transcript. You may be surprised at the nuggets you can glean from hearing management speak.
The best companies also have excellent management teams. Those that get defensive or struggle to answer simple questions may point to bigger problems festering below the surface. However, management teams that stay levelheaded and focus more on the big picture than on getting bogged down in the present tend to implement the strategies that separate great companies from good ones.
However, it's not just the companies that stay even-keeled during tough times that shine. Top companies also tend to downplay their short-term success, boast less, and focus more on multiyear development than simply beating expectations for a single quarter. On the flip side, shaky companies can sometimes flaunt their success when times are good, then suppress their failures when times are bad.
It's possible to pick up some of these cues from the transcript, but listening to earnings calls makes it far easier to decipher what's happening.
5. Decide if the sell-off is justified
As an investor, it's hard to admit when you're wrong. But sometimes, a stock's sell-off is justified. For every big success story, there are many failures. One of the benefits of bear markets is they cast light on weaknesses. If a company is struggling mightily when the economy is just mediocre, not terrible, then it could get a lot worse during a prolonged recession.
By the same token, a company that consistently puts up decent results even when times are tough builds a track record that long-term investors look for.
Focus on long-term growth
Wall Street's flinch reaction to earnings can sometimes be too extreme to the upside or downside. It's better to digest the earnings and make independent assessments. After all, the stock price merely represents the consensus value of a company in a given moment, which can grossly overvalue or undervalue the company based on sentiment, recency bias, and a slew of other factors.
Long-term investors know that the real gains are made as investments compound over time. Hopefully, these steps will empower you with the tools you need to avoid getting swept away in volatile price action this earnings season.
