Exchange traded funds allow investors to gain diversified exposure to broad market segments, but this does not mean that ETFs are entirely immune to effects of single stock earnings results.
“Earnings season is particularly important for investors in industry- or sector-focused ETFs,” Todd Rosenbluth, director of ETF research for S&P Capital IQ, told Investor’s Business Daily. “Those products tend to be more concentrated at the stock level and are definitely more concentrated at the industry level.”
One company’s quarterly earnings and revenue growth could be mirrored multiple times across the same industry. If a whole industry does well and a early earnings announcement reflects the strength, many other firms in the same sector may report similarly favorable results, or vice versa.
For instance, Illumina (NasdaqGS: ILMN) revealed a sales miss and an earnings beat on Wednesday. Given its weak results, investors of the iShares Nasdaq Biotechnology ETF (NasdaqGS: IBB), which includes ILMN among its top ten positions, should watch for any spillover effect on other companies in the industry.
With broader stock ETFs, like those that track the S&P 500 index, Rosenbluth suggests that investors take a broader view or see if most companies are expected to beat estimates.
“For more mature companies, a stock will move based on how well a company’s earnings or revenue come in, relative to expectations,” Rosenbluth said.
While smaller companies may have no earnings to report, which may be more typical of small pharmaceutical or biotechnology names, these companies may have more important announcements, like early-stage drug developments or new products.
Recent studies have also pointed to greater herd mentality or lock-step moves in the market. As the popularity of index-based ETFs grows, correlation between individual securities in sectors are also on the rise. Many index-based ETFs employ sampling techniques or carve out specific areas of a broader market to provide a general investment theme, and with more investors utilizing the ETF investment vehicle, observers have pointed out that correlation among ETFs’ underlying securities have increased. [Increased Index ETF Usage Promotes Stock Correlation Across the Board]
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.