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By Jason Stipp | 07-31-2013 11:00 AM

Don't Make These Earnings Errors

These three common behavioral mistakes can trip up investors as they digest earnings data, says Fuller & Thaler director of research Raife Giovinazzo.

Jason Stipp: I'm Jason Stipp for Morningstar.

Earnings season can provide stock investors with a raft of new information on their stocks, including recent performance as well as forecasts, but how you use that information could be critical to your investing success.

Here to talk about some common behavioral pitfalls around earnings season is Raife Giovinazzo. He is a director of research at Fuller & Thaler and also a co-manager of Allianz Global Investors Behavioral Advantage Large-Cap Fund.

Thanks for joining me, Raife.

Raife Giovinazzo: Thanks for having me.

Stipp: You say several behavioral mistakes may rear their head during earnings season. Let's discuss three of them and how they might play out as people are getting the news about their companies. We are in the midst of earnings season now.

The first one you say is anchoring. Can you describe anchoring and how it comes to play during earning seasons?

Giovinazzo: Anchoring is a rule of thumb that all people use, and that's starting with an anchor, a starting number, and adjusting away from it, but typically people don't adjust enough. It is part of why car dealers will often have a very high sticker price, because they know you'll adjust down as you're thinking about the true price, but you probably won't adjust enough.

To use a hypothetical stock example, let's imagine that last year's quarter, earnings were $1. Let's imagine that the forecast for this year is $1. Earnings come in, and the quarterly earnings, let's say, are the annual equivalent of $1.30. It's a big jump. What people are likely to do is … anchor on the old number--they're going to anchor on the analyst consensus forecast of $1--and they'll say, the sustainable earnings are somewhere between $1 and $1.30. Now that's actually a very good rule of thumb, and that's why people use it. But you can imagine there are going to be times when it's completely wrong, and you're going to miss out on a very big and important earnings surprise, and that's the danger of anchoring.

Stipp: The second effect that we sometimes see in earnings season is called the "disposition effect," and I think this can come into play around earnings seasons, because we often do see stocks re-price based on what their forecast is or based on what their results were in relation to expectations.

Can you elaborate on this disposition effect, and how it may come into play and how we can perhaps work against it?

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