Anticipating Yahoo's 2005Q4 Earnings Announcement

True to the company's usual celerity in announcing quarterly earnings, Yahoo (YHOO) kicks off the year-end 2005 reporting season this coming Tuesday, January 17, after market close. Analysts are expecting $0.17 earnings for the fourth quarter of 2005 on $1.07 billion revenue excluding traffic acquisition costs (TAC). This revenue number is 36% above the figure reported a year ago and at the upper end of the company's guidance of $1.032-$1.082 billion given last October.

With 2005 now behind us, market reaction to Yahoo's earnings report will largely hinge on the company's guidance for 2006. Analysts are projecting revenues excluding TAC of $1.09 billion for 2006Q1 (33% above 2005Q1) and $4.77 billion for the year (29% above the projected 2005 figure). Because the quarterly earnings releases and conference calls provide the most in-depth view into the financial health of a company's business, the quarterly earnings announcements often trigger high price volatility, as the market responds to the news. Over the past few reporting periods, the single-day price movement of Yahoo's stock directly following reported earnings and guidance has been varied--down as much as 11% (following 2005Q2 earnings announced in July, 2005), and up as much as 16% (following 2004Q1 earnings announced in April, 2004).

On earnings announcement day, the million dollar question is: will the company report and guide higher or lower than expectations? Based on long-term fundamentals, I have held shares of Yahoo for most of the past decade (view: Yahoo, with their unparalleled site stickiness and community feel, built on broad content offerings, strong relationships with content providers and user involvement in content creation, is best positioned among Internet leaders to benefit from increased global online usage over the years ahead). Though I tend to invest for the long term, I am also interested in examining shorter-term stock behavior to see if any trading insight that can be gleaned for positioning purposes just prior to earnings announcements.

In an attempt to identity any patterns in price movement occurring around the earnings announcement dates, I have analyzed data from 2002 through 2005. By aligning all of the earnings announcement dates (defined as Day 0) for the 16 quarterly reporting periods, I make the following observations about short-term price and volume movement:

1. With high regularity, volume increases dramatically on the trading day following the earnings announcement. Volume is also elevated during the trading session just prior to the announcement, as traders adjust their positions in anticipation of the upcoming earnings release.

2. Unlike volume, however, the stock price does not move in such an obviously predictable way. Although price volatility noticeably rises, the direction of price movement exhibits little, if any, regularity. Note the volatile "spray" of stock price movement following Day 0 in the chart to the right. The stock price sometimes moves higher and other times moves lower in reaction to earnings news.

To gauge any cause-and-effect embedded in the short-term price and volume data, I have examined the relationship between price or volume changes just prior to the earnings announcement and the resulting price movement following the announcement:

3. For the 16 quarterly reporting dates during the past four years, there is no simple relationship between price movement prior to announcement and price movement immediately following announcement. In other words, pre-announcment price information does not appear to provide insight into the direction of post-announcement price action.

4. Likewise, pre-announcement volume does not appear to be a reliable indicator of the direction of post-announcement price movement. However, as shown in the figure to the right, one relationship that seems to hold is that higher pre-announcement trading volume leads to higher post-announcement price volatility--note the larger oval to the right in the diagram.

So, as might have been expected, we have the familiar (see Are Big Price Moves Predictable? (I) and An Example of Typical Price Behavior (II)) conclusion that:

Past (volume in this case) volatility begets future (volume and price) volatility. On the other hand (much to our chagrin), the past offers little, if any, useful information regarding the direction of future price movement.

What, then, can we say about how Yahoo ($39.90 at close on Friday, January 13) will trade following the 2005Q4 earnings announcement this coming Tuesday? While unable to make a directional prediction with any confidence, I offer the following:

Watch pre-announcement trading volume of Yahoo during the day on Tuesday. If more than about 45 million shares trade during the day (i.e., more than double the prior two-week average of 22 million shares, expect a large gap up or down (could exceed 10%) in price after the close when earnings are announced. On the other hand, if daily trading volume on Tuesday is less than aboout 35 million shares, expect more muted price action following the announcement.

The data seem to indicate that the market is somewhat successful in anticipating large surprises--either blow-out earnings or a significant earnings miss, which lead to a large gap up or gap down, respectively, in price following the earnings announcement. Unfortunately, the essential piece of information required to profit from trading the market--i.e., direction of price movement--remains as completely hidden within the foggy haze of numbers as ever.