Episode 121

The Art of Corporate Body Language and its Impact on Stock Prices

Articles From: Wall Street Horizon
Website: Wall Street Horizon

By:

VP Research

Wall Street Horizon

It ain’t what you say, but the way that you say it. Investors know with some certainty that companies will release earning four times each year. But the art is in the timing. Wall Street Horizon’s Head of Research Christine Short discusses what happens when companies mess around with announcements dates, roadshows and even speakers as they unveil earnings, product announcements and, as Steve Sosnick explains, dividends.

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Summary – IBKR Podcasts Ep. 120

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Andrew Wilkinson 

Welcome to this edition of IBKR podcasts. I’m your host, Andrew Wilkinson. In this episode, we’re going to be digging not only into the earnings data that companies report, but also why what company executives say matters. I’m joined by Vice President of Research at Wall Street Horizon, Christine Short, who is an expert in the field. Welcome, Christine. And I’m also joined by my regular co-host, Steve Sosnick, who has a long history as a consumer of corporate data. Welcome to you both. 

Steve Sosnick 

Thank you, Andrew. 

Andrew Wilkinson 

Christine, let’s start with you. At Wall Street Horizon, your research team closely tracks something you refer to as “corporate body language”. For the benefit of the audience, can you explain what that is and how it relates to corporate events? 

Christine Short 

Thanks so much for having me, Andrew and great to be here with Steve to talk about corporate events. You’ve asked about corporate body language. That’s something we really like to discuss at Wall Street Horizon. It’s a term that we dubbed to represent the nonverbal cues that companies give the marketplace about their financial well-being. And those can either be intentionally or unintentionally. Typically we see companies change the date and time of their corporate events, or it could even be in the content changes of those events. So what do I mean by that?  

Well, when we look at date changes, we’re primarily referring to earnings date changes. There is a whole body of academic research out there on when companies report whether it be a specific time of day or the time of the week and what that might say about an upcoming earnings call and what’s going to be said on that call. There’s specifically one study out of MIT and the University of Texas that uses Wall Street Horizon data that showed when a company confirms an earnings date that is later than when they typically reported, that tends to correlate very highly and positively with bad news coming out on the call.  

The reverse is also true. When a company reports a date that’s earlier than they would typically report, often times that’s correlated with good news on the call. So why is this important? Well, because we know there’s a lot of volatility around corporate events. You don’t want to miss something, and that includes not missing important date changes because earnings calendars have strong predictive power for firms, earnings news and their future returns. In fact, the study that I just mentioned showed that advancers outperformed delayers by more than 2.5% in the month after the revision and the positive value is realized from advancers and negative value from delayers. So that means investors can gain equally from both types of changes. It also showed that the timing of earnings events impacts not only the performance of equity stocks, but also the pricing of options. So while there was what they call “the content signal”, which was indicative of firm’s future earnings, they also found a volatility timing signal. So it was relevant for options prices as options markets respond immediately to that timing signal. So all of that is to say that corporate event changes should be treated as a significant source of information ahead of the actual announcement. And investors who track these changes can typically generate additional alpha or avoid risk in their portfolios. 

Andrew Wilkinson 

Steve- Christine noted there that she gave a special shout out to options and timing. You spent a career making options markets. How did you use corporate body language? 

Steve Sosnick 

Well, one of the things that options market makers do that’s quite relevant is they need to keep track of what we call the “known unknowns” and earnings are probably the single most important known unknown that we have to deal with. The term refers to- we know that something is coming. So we know it, but we don’t know what it’s going to be. We don’t know what the earnings are, but it’s not just the earnings number because there are also variables around it and this is where we this is where we utilized Wall Street horizons to help us out. So what we would do is basically we would put in some sort of boost around the earnings date. You know, company XYZ typically moves 5% after earnings and so we’re going to, we’re going to price that into our into our volatility assumptions. And you start pricing that in way ahead. And so it’s got a very minimal effect maybe two months in advance. But as you approach the earnings date that that grows in importance because if you think about implied volatility when it’s measured annually, it’s really a series of daily volatilities.  

So you’ve got the background noise of the daily volatility and then this one-day spike around earnings. And the product, it wasn’t as big of an issue when options expired monthly because you only had 12 expirations to worry about and you only had really a subset of the stocks that tended to report in the week before the week after expiration. So you could sort of muddle through those. Then weekly options came about, I think it was in 2005. And we realized that all of our most important stocks had 52 expirations a year. And that meant that you had to get it right, you know, instead of sort of a 1 in 12 chance that an earnings date would cross an expiration. You had a one in 50, let’s call it a one in three chance because of four quarters.  

You had a one in 13 chance essentially that would cross a weekly expiration. And it becomes very critical because you don’t want to be paying for volatility that you’re not going to use because you think an earnings date is before an expiration and the company is likely to be after or vice versa. You don’t want to underprice it because you think it’s going to be after a weekly expiration and the and the date is going to be beforehand. 

And so we realized we needed help and Wall Street Horizon is who we chose to help us out with that. and we realized they looked at it in a much richer way than we did. You know, some company will tend to be the Tuesday of the 40th week. Whereas we would just kind of be like, yeah, it tends to be like a, you know, around the 12th, let’s say. But there was a lot more granularity to it. And also when you’re a market maker, to a certain extent you’re playing goalie. The rest of the world is taking shots at you. And so we didn’t necessarily have an information advantage in how to price things. We have an information advantage we’d like to think in terms of the market activity. But we certainly did not want to be at an information disadvantage. When you think about all the various analysts and people who specialize in a lot of the biggest companies, we couldn’t match that. So we utilized Wall Street Horizons to make sure that we were on the right side of our earnings calls. And it definitely saved us a lot of money because if there was an adjustment or if there was some reason to question an earnings date, we would make that change in line with everybody else. There would always be somebody who guessed it ahead of us, but I would say that thanks to using Wall Street Horizon, we were not caught off guard very often and that that’s really the reason that we that we found the product very helpful. 

Andrew Wilkinson 

Christine, you told me recently that you aggregate the information into an index. Can you talk a little bit then about the late earnings report index? Is that the LERI? And what it’s been signaling to investors this year? 

Christine Short 

Yeah. So the LERI we developed as a way of aggregating all of these date changes like you said, in determining more or less corporate sentiment going into an earnings season. So instead of looking at stocks one off and seeing who has pushed a date or who’s reporting, later than usual. And to Steve’s point, I mean, there’s two ways to look at this data. As an options trader did he need very accurate data. So instead of just saying OK, they always report on the 40th week of the year on a Tuesday, we’ve been collecting this data for 20 years, so we can really pinpoint down to almost a day or two. Historically this is when this company has reported. 

Not only do you need that information, but you need the information if there is a change. So now they’ve confirmed a date, but they’ve actually revised that and they’ve pushed it out a week and does that cross an options expiration date? And so instead of looking just at one-off companies, we created the LERI, as you said, the late earnings report index that tracks all of these outlier earnings date changes. Amongst US publicly-traded companies with market caps of $250 million or higher, we chose this group. We do collect data on 10,000 companies globally, we chose US just because of the reporting structure. It’s quarterly earnings, there is some consistency there and then we chose a market cap of 250 or higher just to weed out those micro caps, who tend to be a little more inconsistent with their reporting. But the LERI has a baseline reading of 100, and so we say anything above that indicates that companies are feeling a little uncertain about their current and short-term prospects. And then a LERI reading below 100 suggests companies feel like they have a pretty good crystal ball for at least the near term.  

Just to give you an idea of how that metric has been tracking currently for the third quarter earnings season, which we’re currently working through right now, the LERI stands at 120, so we’re well above that 100 mark. It’s actually the highest reading we’ve seen since the COVID-19 pandemic. And while earnings season has been pretty upbeat this far, I think about 78% of companies have been beating estimates. It’s the sentiment on those calls from CEOs and CFOs that’s been a little cautionary.  

And I think that’s why you’re seeing stocks trade lower at the minute at the moment, even if they are beating, you know you tend to see, yes, if a company misses earnings expectations, of course the stock is going to trade lower. But even seeing companies that are coming in and coming in higher than analyst expectations are still going lower and I think that’s because of this sentiment, it’s because of outlooks. Q4 estimates are coming down, so we’ve only been tracking the LERI for about 6 quarters now, but so far, it’s served as a leading indicator for corporate sentiment. 

Andrew Wilkinson 

Christine, is there anywhere on the Wall Street Horizon website where people can view the LERI? 

Christine Short 

Yes, we write about it almost weekly on our research blog, so just wallstreethorizon.com > research blog, and they can read the weekly updates to the LERI and any of the other content that we’re putting out on corporate events. 

Andrew Wilkinson 

So Steve, the acid test then- can a trader incorporate the LERI into his or her decision-making process and what does something like this tell you about overall corporate sentiment? 

Steve Sosnick 

Well, I think you know from the macro point of view, it’s really very useful to know how companies will have their information interpreted. You know, when I think about it this way, Christine mentioned 78% of the companies in third quarter so far coming in above estimates. That’s about normal. So you know you really have to come in a little bit better even to be of the norm. Meeting your estimate isn’t really necessarily good enough, so you have to beat it by a little bit.  

Well, the problem is if everybody’s above average, what’s average? So you need something else to interpret that. I would love to see if there’s some research on the reaction vis-a-vis the level of valuation in the market. In general when stocks are priced relatively fairly and I’m speaking sort of, low PE low PEG ratio- the things that fundamental analysts look for. They have a little more leeway to disappoint. When stocks are priced very expensively, high PEs or they’ve had great performance, et cetera, et cetera. The bar is raised really high, you know, and I think about some of the some of the high-flying mega caps that had a rough third quarter earnings season. Or earlier this year and actually last year, there was a mess of them because when things are very highly valued, you don’t have room to miss. And so I think something like LERI tells you that. Should I be leery of the corporate body language? Do I want to go into earnings season with a relatively sanguine approach, sort of a glass half full approach? Or do I want to go with a glass half empty approach? And that will guide my thinking. You know on a macro index or a micro level, it’s one more piece of the puzzle, but it might be one of those things that’s very helpful in —terms of should I be biasing? Should I be biasing myself to the long side or the short side? Should I be biasing myself toward being long vol or short vol going into earnings? Considering that this backdrop is there? 

Andrew Wilkinson 

And I should mention that much of the Wall Street Horizon data is available using the API on Interactive Brokers platform. Christine, are there any other corporate event data sets we could use to make a determination regarding a company’s financial health? 

Christine Short 

Yeah, I mean, I know we focused on earnings here. That’s sort of our bread and butter, but we do collect data on 40 other corporate event types. One we take a look at quite often is investor conferences and who’s speaking at the conference? Is it someone in the C-Suite? Have they cancelled their speaking appearance? Have they replaced someone in the C-Suite? You know, maybe the CFO was meant to speak and now it’s the VP of Finance. What’s that mean about a company’s financial health? Have they pulled out of the conference altogether? Has the conference been cancelled?  

You know, so there’s a lot of different aspects that you can look at around investor conferences as well as shareholder meetings. I think before COVID there used to be an indicator for shareholder meetings that showed if the meeting was held more than 50 miles away from the company headquarters, it was kind of a bearish signal, but now that things have gone virtual, I’m not sure there’s much merit to that one anymore. I spoke earlier about timing of earnings. It used to be you didn’t want to hold or if you were trying to hide bad earnings, you would never report on a Friday afternoon before a three-day weekend or something like that. And then that flopped the other way, where if you really wanted to be recognized, you reported on a Friday afternoon because no one was expecting it. So all eyes were on you and that actually happened last quarter in the second quarter of 2023, Palantir, who is always a Monday report, I mean they’ve reported on Monday, I think almost every quarter since they’ve been public. They decided to report a Friday after the bell, which is like almost unheard of, especially for a company of that size. They had stellar results and it was almost like a PR stunt.  

It’s like everyone look. Everyone did and the stock flew. So some of these signals are flip flopping as everyone kind of gets on board, then maybe it switches the other way. Now it’s, you know, do you report during a very busy peak week of earning season to very bad news? Maybe you want to report in during the week that most of the magnificent 7 are reporting. Because all eyes are going to be on them, right? So there’s things like that.  

We also have another term we’ve dubbed: “event clusters”. So, is there a company that is just doing it everywhere, right? Are they at all the conferences? They’re doing their own investor meetings and we profiled in video this last summer. It was like they had their earnings call and then their shareholder meeting and then they were at every single major conference that was in the tech industry, AI and they had some big speakers. Often it was their CEO, Jensen Huang, doing all of the speaking slots or someone else- another C-Suite executive. And so we saw that as very bullish for the stock and you actually saw the stock move in lockstep. And so they were out there controlling the narrative, making sure they were on investors/ radar and just and, you know, having a hand in all of kind of the hot tech summer conferences.  

And there’s other events that you maybe don’t think of in the same light as a scheduled earnings call or a scheduled investor conference. Things like buybacks and dividends, which we really have our eye on right now because those seem to be shifting. In Q3 and now in Q4, we’re seeing buybacks are waning a little bit. Dividends right now, dividend increases are at their lowest level I think in five years. I look back to 2018 and these are the two main ways that companies return value to shareholders. So just another way to evaluate how a company is doing. It seems from those two metrics that maybe they’re starting to hold back a little bit.  

So, I think just to wrap it up, in any environment, you’re always looking to have the most inputs possible when you’re making decisions. I think specifically right now in the current trading environment, you know, lower volatility right now, low trading volume. Investors need additional sources of information to make those investment decisions and reading the corporate body language is just another piece of that mosaic. I wouldn’t say I’d make decisions based on a company solely moving their earnings date. But with all of your other bespoke data sets, if it’s all moving in one direction, and they moved their earnings date two weeks late, well then I would use that as an input when I’m making decisions. 

Steve Sosnick 

And if I may, just the one thing I harped on how expensive it was if we had the wrong earnings date. The thing that was even more expensive was having the wrong dividend date.  

Christine Short 

There you go. 

Steve Sosnick 

Because if you have a dividend crossing expiration, remember options trade off of forward values, dividends are the single biggest input into forward values. Granted, we have positive interest rates now, particularly. But even so, if the companies got a decent sized dividend and you have that wrong, that was incredibly painful. We did a lot of our own work on dividend timing, but we used Wall Street Horizon as a key element in making sure that we had that right. Because the market will find you if you’re wrong with your dividends. 

Andrew Wilkinson 

Steve Sosnick, chief strategist at Interactive Brokers, thank you for joining me. And Christine Short, Vice President of Research at Wall Street Horizon, thank you very much for joining me today. 

Steve Sosnick 

Our pleasure, Andrew. 

Christine Short 

Thank you so much. 

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