Institutions act quickly when a company surprises to the downside. A quick reaction on the part of an institution means that some of the biggest holders could be out in force, slamming the stock. An earnings surprise is viewed as a fundamental trend that is likely to continue.
Portfolio managers do not want to be held accountable for holding onto a losing position when a company disappoints. A negative earnings surprise is a hard and cold fact that says something is wrong. At the end of the year, when performance is reviewed, portfolio managers do not want to have to explain why they decided to hold a large position in a company that produced evidence that it could not deliver the goods. Day traders should be extremely wary of trying to scoop up bargains after negative earnings surprises,
*"Trigger-Happy: Merrill Lynch Poll Sheds Light on the Vicious Punishment." Barron's, December 8,1997.
because the catalyst and panic will always be to the downside. Bottom fishing on an earnings disappointment is a fool's game and should be avoided.
A positive earnings surprise is valuable confirmation that the company is in good shape and has delivered on its promise. Portfolio managers believe that action speaks louder than words, and good news in the form of earnings is the best possible reflection of positive action. With a positive earnings surprise, the main panic that occurs is the shorts that get squeezed.
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