There are few events in the stock market that cause as much concern and confusion as profit warnings. Reports of an earnings 'miss', a slump in trading or an unexpected setback, are naturally loathed by the market. These gut-wrenching events tend to be punished with instant and savage falls in stock prices. Shareholders caught in these situations face the emotional turmoil of sudden losses and the agonising decision of what to do next.?

One of the defining features of profit warnings is that they're shrouded in market myths, which only add to the sense of confusion. For some, profit warnings are “an ideal buying opportunity”, while others believe they ”come in threes”. Some use them as “an opportunity to average down” while others don’t dare ”catch a falling knife”.

With all this in mind, a research team at Stockopedia.com’s HQ in Oxford carried out an investigation in the summer of 2016 with the goal of building a profit warning database. The results of that work are brought together in The Profit Warning Survival Guide, where we set out to definitively answer the question of what to do in a profit warning.

While most investors hang their decision making on gut instinct or a subjective analysis of the underlying business story, we’ve taken a long, hard, rational look at the statistics.

An initial source of data on profit warnings was the daily Small Cap Value Report, written by Stockopedia’s superb small-cap analyst, Paul Scott. There are around 500 shares covered in Paul's small cap universe, which incorporates more than 25% of the UK stock market. As small caps tend to be a very popular hunting ground for individual investors, the scope of this study is particularly relevant.

We went on to analyse hundreds of smaller company profit warnings over a three-year period between 2013 and 2016 and then constructed a data set that has few peers in international research. From the data we aimed to answer several questions including:

  • How far do stocks fall on a profit warning ?
  • If a stock suffers a profit warning, is it likely to recover ?
  • Should you buy or sell on a profit warning ?
  • Is there any way to avoid profit warnings ?
  • Which sectors are most hit by profit warnings ?
  • Do profit warnings over-react and thus bounce ?

The goals of our research project were to uncover the facts, debunk the myths and…

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