Successful investing isn’t about being right — it’s about being right at the right time. History is littered with examples of investors who were right, but at the wrong time. As the saying goes, "The market can stay irrational longer than you can stay solvent”. One recent story typifies this issue. Ted Aronson was running $10bn in an underperforming US value investing fund from 2011 to 2020. “Our record for the last five years sucks” he said as his investors gave up on him and he closed up shop. Of course, all those value stocks he owned came right back into vogue within months of his fund closing.
So the ideal investment strategy is to avoid the opportunity cost of sitting on underperforming shares that are going nowhere. If you could pinpoint undervalued shares at the exact moment when the market begins to wake up to them, wouldn’t that be something?
The Catalyst: 'Ahead of Expectations'
Three simple words: "ahead of expectations" can be game changing for share sleuths seeking to be right at the right time. Investors that read all the trading updates and results announcements from the RNS (regulatory new service) are always on the lookout for catalytic moments - and these three words can mark them.
Announcements like these are signals that the analyst community, who set the earnings estimates for a company, are well behind the curve. When low expectations are beaten in undervalued shares, share price fireworks can follow. It's even better if the announcement is "significantly" or "materially ahead of expectations".
Normally share prices jump on such news which of course is deeply off-putting. “Damn, I knew that was a good stock” you think to yourself, before sulking off to find something else that hasn’t risen. Big mistake.
The Drift: share prices continue in the same direction
The market can be quite slow to fully revalue shares that have announced a surprise on the upside. While a first day jump is common, what’s less well understood is that shares tend to continue to rise in the same direction over the coming weeks and months. This phenomenon, known as the Post-Earnings Announcement Drift (PEAD), is well-documented in academic research.
In simple terms, investors tend to under-react to an upside surprise. The first day jump often isn’t enough, and a share price trend begins in the same direction for the next few months to…
