DID YOU KNOW?
About the Blackout?
In this edition of Did You Know? we discuss the pre-earnings time sensitive ban on company executives buying and selling their own stock, known as the Blackout.
A publicly traded company reports its earnings each quarter of the year (4 times), with the dates provided well ahead of time to the public. Prior to these announcements, there are what are referred to as “whisper numbers,” usually estimated by financial analysts who cover that company. These sales/earnings estimates become the “expected” figures to be reported on that date, and investors react according to those numbers.
As we note in our publication, When to Buy and When to Sell: Combining Easy Indicators, Charts, and Financial Astrology (now available on Amazon), this creates the commonly used trading strategy of “Buy the Rumor and Sell the News.” This phrase signifies the practice of opening long positions in company stocks that are expected to “beat” their previous sales forecast (rumor), driving up the price prior to the actual announcement (news). Late comers to the trade then become vulnerable to a sell off after the news, as some of the internal fundamentals may not support the rise in price. Additionally, on the day of earnings, a company will also provide “guidance” for the following quarter or two, which is another “forecast” that can easily change. The price action on the day of the earnings announcements is affected by the guidance as much as the actual figures, sometimes more. So, this cycle of rumor-to-news-to-rumor creates a more speculative environment leading into earnings season and beyond.
There are three scenarios at the time of a company’s earnings announcement: The first is known as a “beat,” when a company surpasses their earnings per share that they previously forecast. The “whisper number” is NOT the same, unless they match. The second is known as “in-line with expectations,” which is self-explanatory. There is usually a small margin of error allowed, based on the company market cap, that is considered in-line. The third, of course, is an earning’s “miss,” which usually creates the largest reaction from investors (usually down).
Seemingly more important on many occasions, however, is the “forward guidance” provided by the company. As also explained in our publication, markets look about 6 months forward on average, and want to know what will be happening, not what already did. In the situation where a stock has a large run-up prior to their announcement, the price has already made the movement related to the current quarter. When forward guidance is negative (slowing sales or other discouraging news) a “beat” may be ignored, causing the “buy the rumor, sell the news” reaction.
This all leads to the “blackout” period enforced upon companies and its executives/employees. Companies often buy back shares of their own stock or buy and sell their personal shares/options for several reasons, which are not important regarding this blog. Executives within the company are required to report these transactions, however they are usually allowed time to do so. As you can imagine, insider (executive or employee) transactions can move the stock price significantly, based on the size of the purchase or sale, but can also cause heavy price action based on who purchased or sold, and why. The speculation surrounding the transaction can be just as important as company news, earnings announcements, and analyst upgrades or downgrades.
For this reason, a time frame when companies cannot buy back shares, dubbed the blackout, has been created. This time frame normally occurs at least 2 weeks prior to the next announcement, and 2 days after. This “blackout” protects the everyday investor from any manipulation surrounding equities, and prevents the “insiders” from trading their earnings to their benefit. Since the normal time allotment to report transactions is 10 days, it would be more than enough time to take advantage of information received that was not available to the public. Politicians are allowed up to 45 days to report any transaction over $1,000, which can be even more advantageous. During the blackout, no owner, executive, or employee can be issued shares, sell shares, and/or exercise stock options. There is no actual “set” time for the overall market for the blackout, as companies report earnings on different dates, usually over an approximate time frame of 4-5 weeks. The common annual time frame for these “blackouts” occurs in late March to early April, late June to early July, late September to early October, and late December to early January. For any specific stock, research the next earnings date and their blackout conditions.
For the past decade plus, 27% of all S&P gains are credited to the existence of company buybacks, as these purchases lessen supply, and push up stock prices. This figure is even higher than that of the Federal reserve bond buying program. As a result of this “rule,” the blackout periods are often met with a decline in the overall market, though it is usually temporary. Share buybacks are also normally more popular during lower interest rate conditions, as companies can borrow money at a lower rate to finance the purchase of their own shares.
These times can be beneficial to “buy the dip” with leading stocks for any long-term or intermediate investor, or trader, as equities in uptrends generally continue that pattern after the blackout.
