Having led U.S. equity markets out of the pits of despair in March, “big tech” has a lot to prove heading into the heart of Q2 2020 earnings season.

And if earnings season were compared to a horse race, it might be said that one of the favorites stumbled straight out of the gate when Netflix (NFLX) reported earnings last week.

Netflix is part of the famous “FAANG” group of mega-cap technology stocks that includes Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX) and Google (GOOG)—the acronym created using the first letter of each company’s name. 

Netflix earnings simply weren’t that encouraging, especially as it relates to projections for 2020 and beyond.

While revenues and new subscribers were up in Q2, compared with last year, net income and projections for Q3 weren’t nearly as rosy. Netflix attracted a huge influx of new subscribers during the first half of 2020, but the company’s Q3 projections indicate subscriber momentum may fade.

Netflix added roughly 25 million subscribers during the first half of 2020, but the company expects only 2.5 million more in Q3—about half the number that market analysts projected. It’s that slowdown in subscriber growth that dampened excitement around the stock and killed the momentum that had pushed the stock to an all-time high earlier in summer.

And while projected subscriber numbers may seem conspicuously low for Q3, bear in mind that anyone who didn’t sign up for Netflix during the first half of 2020 probably never will.

Conversely, Netflix’s declining subscriber growth doesn’t necessarily suggest that other corners of the technology sector are equally fragile. Market participants will soon find out whether internet search (Google), social media (Facebook), gaming (Nvidia) and digital commerce (Amazon) fared any better in Q2.

Another weak report by a FAANG company would likely disappoint investors and traders even more than the Netflix report, which pushed the stock down 6.5%.

The other FAANG reports will unfold according to the following schedule: Facebook (July 29), Apple (July 30), Amazon (July 30), Google/Alphabet (July 30).

The corporate earnings season occurs quarterly when companies publicly release financial data that provides investors and traders with information they use to evaluate each company’s investment potential.

One of the most important metrics that companies make public during earnings season is Earnings Per Share, or EPS. EPS is calculated by dividing profit (or loss) by the number of outstanding shares, and markets view it as a universal indicator of profitability.

Before earnings season, analysts from a wide range of financial institutions release their own internal forecasts for EPS (by company and market sector). The number of analysts for a given company varies and often correlates with the size of the firm. For example, mega-cap companies, such as Amazon, Apple and Google, are typically followed by a flock of analysts, perhaps 30 or more.

Smaller companies that aren’t as widely known might have only two or three analysts who follow the company.

The earnings projections put forth by those analysts are compiled and averaged, which provides investors and traders with a “consensus number”—a benchmark to compare with the earnings figure each company furnishes.

Analysts often lower consensus estimates when economic conditions deteriorate. In 2020, they have consistently lowered projections to account for the impact of the ongoing coronavirus pandemic. That means that if a company “beats” consensus estimates in 2020, they are in fact only beating estimates that have been revised lower—not the original projection.

For example, in the case of Netflix, the consensus estimate was an EPS of $1.81, but the company reported an actual figure of $1.59. It failed to meet even the lowered expectation.

As shown below, the value of the S&P 500 hasn’t declined as much as EPS projections, which could indicate market participants expect only a temporary dip in profits. Other reasons for sky-high valuations (relative to earnings) may relate to the U.S. government’s strong fiscal response and the Federal Reserve’s unwavering support for the markets.

In terms of stock performance after earnings, movement can vary greatly—ranging from a sideways move (i.e. unchanged) to a huge gap move in either direction. It depends on what was expected and what was reported.

Beyond EPS, investors key in on nuances associated with different market sectors. For example, Netflix subscriber growth can outweigh EPS or even sales growth.

For a company like Apple, earnings and revenue still matter, but investors also key in on sales of iPhones, iPads and computers—and technological breakthroughs (i.e. artificial intelligence or driverless cars) for clues about how the company will fare.

When trading earnings events, market participants use a variety of approaches, ranging from stock-only positions to options-based strategies.

To learn more about trading earnings, readers may review an installment of Options Jive on the tastytrade financial network. It explores corporate earnings and associated options trading strategies. 

To follow earnings developments as they happen, readers can also follow TASTYTRADE LIVE weekdays from 7 a.m. to 3 p.m. Central Time.

“Sage Anderson” is a pseudonym for a contributor who has traded equity derivatives and managed volatility-based portfolios as a prop trading firm employee. He is not an employee of Luckbox, tastytrade or any affiliated company. Readers may direct questions about this blog post, or any other trading-related subject, to support@luckboxmagazine.com.