Equities · E3 · 8 min
Earnings and events
Explain why a share can fall on good results, read the move options expect, and size what index changes and takeover bids do to a price.
In the news: “Shares fall 8% despite an earnings beat”: why the reaction depends on what investors expected.
The essentials
- Beat or miss
- Results are judged against the , the average analyst forecast, not against last year. Earnings of 52p against a consensus of 50p is a 4% beat; the surprise, not the growth, moves the shares.
- Guidance and quality
- The company’s own forecast, its , often matters more than the result: a beat paired with a cut to next year’s forecast usually sends the shares down. So can a beat built on one-offs, or one after a rally into results.
- Implied move
- A pays on a move either way, so its price divided by the share price is the . A 120p straddle on a 2,000p share implies about 6%, to set against the stock’s past moves on results.
- Index inclusion
- In an , trackers must buy a joining company: tracker assets × its weight, mostly at the close before the change. £200 billion tracking and a 0.5% weight make £1 billion of buying.
- Merger arbitrage
- Buying a takeover target below the cash offer to collect the gap when the deal completes: 490p against 500p is 2%, about 6% a year over four months. If the deal breaks, the target can fall back to its pre-bid price.
The move options expect
Implied move ≈ straddle price ÷ share price
- straddle
- a pair of options that pays the size of the move, up or down, expiring just after the results
How it works
1. Results move shares against expectations
Companies report their profits regularly: in the US every quarter, and most UK companies twice a year. A share doesn’t move on whether profit went up. It moves on whether profit beat what investors expected. If profit rises 20% but everyone expected 30%, the shares usually fall.
2. The consensus
The expectation is measured by the : the average of analysts’ forecasts. of 52p against a consensus of 50p is a beat of 4%. Earnings of 48p would be a 4% miss.
3. Next year matters more
A share’s value rests on future profits, not the quarter just gone. So the company’s own forecast, its , often matters more than the result. A company that beats this quarter but lowers its forecast for next year usually falls.
4. When a beat still disappoints
Two more reasons a beat can fail. Quality: a beat that comes from a one-off, such as a tax credit, while sales miss, says little about future profits. Expectations: if the shares rallied hard before results, investors expected more than the published consensus, so a small beat disappoints.
5. How big a move options expect
Options let traders bet on the size of a move without picking a direction. A is a pair of options that pays out if the shares move a lot, up or down. So its price is roughly the move the market expects: the . A 120p straddle on a 2,000p share implies about 6%.
6. Joining an index forces buying
Index funds must hold every company in their index. When a company joins the FTSE 100, they all have to buy it: tracker money × the company’s weight. If £200 billion tracks the index and the newcomer is 0.5% of it, that is £1 billion of buying, mostly at the close the day before the change. This is an .
7. Takeover bids and the spread
When a company bids 500p in cash for another, the target’s shares rise towards 500p but stop just short, at say 490p, because the deal might fail. Buying the target to collect that 10p when the deal completes is . 10p on 490p is a 2% gain; if the deal takes four months, that is about 6% a year.
8. The risk: the deal breaks
If competition regulators, shareholders or the bidder’s financing stop the deal, the target usually falls back towards its price before the bid. That loss can be many times the spread. So merger arbitrage earns small, steady gains with the occasional large loss, a lot like selling insurance.
Worked example
A stock trades at 2,000p the day before results. The straddle expiring that week costs 120p. Over its last eight results days the stock moved 4% on average, up or down.
- Implied move = 120 ÷ 2,000 = 6%.
- Breakevens: 2,000 − 120 = 1,880p and 2,000 + 120 = 2,120p.
- Compare: options expect 6%, history says 4%.
- So options look expensive, unless this quarter carries unusual risk.
The market expects a 6% move against a 4% average: options look expensive going into these results.
Check yourself
8 quick questions on the explanation above.
Practice
New numbers every set. Misses and guesses go into your review deck.
In the interview
Answer out loud in under a minute, then compare.
A company beats earnings and the stock falls 8%. Why might that happen?
How would you trade an earnings announcement without picking a direction?
What’s merger arbitrage, and what’s the main risk?
Remember
Implied move ≈ straddle ÷ share price
A share moves on the surprise against what was expected, so read the guidance and the implied move, not just the headline beat.