By: Costas Bocelli — February 9, 2019
At True Market Insider, we generally take a "top down" approach to investing.
That is, we begin by scoping out the state of the wider market, and then we drill down into major sectors... sub-sectors...
... and, finally, to individual stock and ETFs.
And every step of the way, we look to see which industry groups, sub-sectors and stocks are outperforming their sector peers and outperforming the market as a whole.
That said, you can sometimes start at "the bottom", which is what we're going to do today. (As you're about to see, we could be in for a quick double-digit bump.)
Say you spotted a technically strong stock (in a strong sector) that, for whatever reason, released a disappointing earnings report? As you know, when a stock disappoints on revenue expectations, it can experience a sell off from investors who become reflexively spooked.
Likewise, a weak stock in a weak sector will sometimes beat its own and analysts' earnings estimates. When that happens, the stock could enjoy a short term "pop".
Makes sense, right? But here's the beauty...
That strong stock that dipped on earnings? The one in the strong sector? There's an excellent chance it's heading back up, and soon. For one thing, about 85% of a stock's price-moves are due to the sector it's in. Probability (and history) say that any dip will be short lived.
Whats more, the stock's momentum is positive. A bad earnings announcement, while not welcome, is rarely enough to push a stock off its main trajectory.
The same goes for that weak stock in that weak sector. Any quick advance it experiences post-earnings is very likely to evaporate very soon. Again, the reason is that its sector is weak, and its momentum is negative.
The upshot here is that it can be an excellent idea to buy a stock after it dips on earnings (or short a stock that pops for that same reason). Get this move right, and you could easily be looking at a triple-digit annualized return!
I'll give you an example in a second. But first, I want to point out a couple of things.
Number one, you can use this strategy every earnings season. Start by looking for stocks that beat or disappointed on earnings...
... then dig into the relative strength attributes of the stock and of the sector the stock resides in.
But, number two, to pull this off, you have to be able to see which sectors are strong (or weak) and how strong (or weak) a particular stock is against its peers and against the wider market. And of course you'll need to see how strong or weak its sector is against the other sectors.
Luckily, you can find all of this priceless info (and a lot more!) at True Market Insiders. At the end of this conversation I'll show you what to do to get it.
Now let's look at an example of what we just discussed...
Spirit Airlines, Inc. (SAVE), out of Miramar, FL, reported fourth quarter earnings of $1.38 per share after the close on Tuesday, February 5th. This EPS was a bit off from the $1.39 consensus estimate, and the stock fell about 3% after the close of trading.
We could talk forever about why the company's results fell short, but we don't really care. Leave that to the pundits, tea-leaf readers and talking heads. We'll stick to being guided by price action.
Ok... Does Spirit Airlines meet the criteria we outlined above? Is it in a strong sector? Is it outperforming?
Our Sector Prophets Pro data program lets us find all that out with a click of a mouse.
When we input SAVE into the Sector Prophets "Position Key" (on of the proprietary tools on the platform) we see this.
Let's zoom in a bit for clarity...
What this view is telling us is that SAVE is part of the Aerospace Airlines sector, and that the sector is ranked 7th out of the 45 sectors of the market that we track. In other words, when you add up the number of Buy Signals that the sector is racking up against all the other sectors...
... you'll find that the Aerospace Airlines sector beats out 38 of them. The sector's Bullish Percent Index chart (BPI) is currently showing Bull Confirmed status. This is one strong sector.
Our snapshot tells us more. Notice the three green arrows.
"Sector RS" tells us how strong (or weak) a particular sector looks when you compare it to the wider market. The Aerospace Airlines sector is in X's. That means the sector is outperforming the market as a whole -- a bullish characteristic that the odds of continued outperformance are on your side.
"Peer RS" tells us how strong a particular stock or ETF is compared to the sector it's in. The word 'Strong' under 'Peer RS' means that SAVE is outperforming its sector -- Aerospace Airlines. This is what we want to see, given our bullish stance.
"Market RS" tracks the performance of a given stock versus the market as a whole. SAVE is "Strong" -- it's outperforming.
So our Position Key has shown us at a glance that SAVE is in a very strong sector... that it's outperforming other stocks in that sector... and that it's outperforming the wider market. It's showing both short-term and long-term relative strength.
We're locked and loaded now. It's time to move on to the stock chart itself...
As of this writing SAVE is currently trading at around $61.00.
If the stock re-tests its December high of around $65, you'd see a 6.5% return. Not too shabby. And we can do much better.
You could purchase the June 52.50 strike Call option for an $11.50 debit.
If SAVE does re-test its previous high, the Call would gain about 17%. If it can do it in 60 days, you're looking at an annualized return of 102%.
Again, this is a great little tactic for playing earnings. You can do it again and again, and you can make bullish and bearish moves.
Have a great weekend!