Navigating Earnings Like a Hedge Fund Pro
Intraquarter data points, sentiment, positioning: DASH and RDDT examples
Earnings season is when the majority of alpha is generated and represents the single most important catalyst for multi-manager hedge funds (Citadel, Millennium, Balyasny). We have seen a large number of tech companies release earnings in the past few weeks, leading to some outsized moves: RDDT -15%, APP +12%, ABNB +15%, ROKU +14%…
To be successful, you need a few critical components: numbers, narrative, sentiment/positioning, intraquarter data points and expectations.
The biggest misconception about multi-managers is that Portfolio Managers approach earnings in a uniform way - looking at flows and positioning, trading on incremental intraquarter data, etc. This couldn’t be further from the truth. Everyone’s process differs in a meaningful way. Yes, there is a strong focus on earnings (which investor doesn’t care about earnings?). Yes, there is an intense focus on risk management. I will write more on this in detail, but please don’t assume that all multi-manager PMs follow the same playbook. That might be true for the average PM, but how long does the average PM last at these firms (hint: not long)? If every PM were doing the same thing, the platform/multi-manager model wouldn’t work.
Incremental data points
One permanent change in the markets is the increasing tracking of intraquarter data points. Earnings can now indeed be pre-traded weeks in advance based on data, leading to greater intraquarter volatility. We will see later in this post how this played out for DASH last week.
Different PMs have different approaches to earnings
How investors ‘play’ earnings largely depends on their specific investment style and process. Some are heavily focused on the upcoming quarter, while others look further ahead, positioning for the next few quarters. Some take a blended approach. There is no right or wrong way to do it. There are extremely successful PMs whose process is focused on either side. Bear that in mind.
Before we dive in, you need to know that getting a stock right during earnings is NOT easy. This isn’t as simple as ‘they’re going to miss estimates → short.’ It’s about positioning, sentiment, expectations and more. Even the best PMs in the world are only right a little more than 50% of the time. That’s where top PMs stand out - they know the companies inside out and understand how to pick stocks.
This isn’t a skill you learn overnight. It takes years of experience. Many senior analysts don’t even have this quality. Anyone can talk about it, but the proof is in the pudding - what’s your track record? You need to study specific trades, understand the what, where and when, and learn from real examples.
If you want to learn how a highly successful Millennium PM generates ideas, thinks about setups, sentiment, sign up now here. This isn’t just theory - you’ll get specific examples and trades from someone who is doing it at the highest level.
Quick example: ROKU +14%.
To give you a quick example of how difficult it can be to pick stocks and get earnings right. ROKU was up +15% last week. Ahead of earnings, most hedge funds were short, but the company posted a big revenue beat and showed a significant acceleration from last quarter. As investors started covering their shorts, it led to a large 14% move.
Earnings season
People generally think about earnings in 4 periods:
Previews - you can see an example of a preview/pitch we did here. An earnings preview is what some PMs require their analysts to write, ideally well ahead of earnings and the sell-side previews.
Pre-print - the week leading up to earnings.
Print - actual earnings release.
Post-print - the week after earnings. This is an adjustment period. What happens next? Has the story shifted? Should we flip the position or exit?
However, I would argue that with the increasing influence of intraquarter data points, these periods have become less rigidly defined.
The key components to earnings
There are a few critical things to get right to be successful:
KPIs/numbers AND market expectations
Story/narrative: What is it that investors are focused on? Why do the bulls like the stock; why do the bears hate it?
Positioning/sentiment: Is the buyside mostly long or short on the name? Who owns the stock and what for? How do the sell-side and buy-side feel about the stock? How is the stock likely to react given an incremental negative or positive information?
Key numbers
Each company typically has a few key levers that truly matter, along with ongoing debates related to those factors, or slightly separate ones. Margins expanding or contracting, revenue/earnings or their drivers accelerating or decelerating, business segment shifts - some combination of these generally drives the stock’s movement.
Market expectations
Market expectations - everything is relative to market expectations or buy-side bogeys. I wrote about NFLX to illustrate this here. But to give you an example from last week, let’s look at Reddit (RDDT).
RDDT, one of the most crowded longs in tech, dropped 16% on its earnings release, despite being up 260% in the past six months. Why did the stock drop so much? Because it failed to meet the (very high) buy-side expectations. They reported $427m Q4 revenue versus bogeys at 438-440m, along with a weaker-than-expected Q1 revenue guide and signs of user growth slowdown.
Expectations. Expectations. Expectations. This is the most common way people get a stock wrong - even if they get the numbers right. Or vice versa: you get expectations right but the numbers wrong (or both).
Positioning & Sentiment - why Reddit dropped so much
How is the stock likely to react? We’ve talked about how positioning and sentiment affect the magnitude of a stock’s reaction when new information comes in. Highly crowded stocks with high expectations can see outsized moves on earnings, even after a small or moderate disappointment/miss.
In Reddit’s case, it was a 16% negative stock reaction. This is because of a relatively poor setup. Positioning was extremely crowded on the long side and the sentiment was extremely bullish heading into the print (with high buyside expectations). When the numbers missed expectations, longs were forced to unwind positions. With so much positioning already skewed long, the slight-to-moderate disappointment led to a sell-off.
DoorDash (DASH): earnings and intraquarter data
I want to now explore DoorDash (DASH) and see how it was traded intra-quarter. Stick with me, you will want to read this.
The stock was up 5% on earnings last Wednesday. The story here has been about strong and accelerating top line (driven by Gross Order Value, GOV - the total dollar value of transactions on their platform), with an underpenetrated restaurant market and fast expansion of other verticals (they recently announced a partnership to deliver Home Depot products from 2000 stores). This is on top of a world-class management team and execution.
It is another favourite consensus long among investors. If we were to distill the name and the story to one key lever, it would be accelerating GOV.
The buyside expectations for Q4 GOV and Q1 GOV guide heading into the print were extremely high.
Yipit and MSci first reported strong Q4 GOV trends back in November!