Earning explosion setup – techno funda investing by Prabhakar Kudva

• Definition: A setup is a “pattern that is based on a structural dependency of the markets and hence that there is an edge in that.”
• Core Principle: Every investment or trading action must be based on a well-defined setup derived from a predictable market behavior.
• Essential Clarity: A robust setup requires crystal clarity on:
• What pattern to look for: Specific characteristics that signal an opportunity.
• When to buy: The precise trigger for entry.
• How much to buy (portfolio allocation): Position sizing strategy.
• When to hold: Conditions for maintaining the position.
• When and how to sell: Exit strategy.
• Benefit: Clear thought around these questions is essential to “utilize The Edge and make meaningful profits.”
• Common Pitfall: Many retail investors fail because “they don’t have a thought through setup…they are trading very randomly there is no process…and they keep jumping from one setup to another setup.”

• Dynamic Success Rates: “Every setup has a different probability of success at different times in the market.”
• Impact on Strategy: A setup’s success rate can vary wildly (e.g., 80% in a conducive environment vs. 10-20% in an unfavorable one).
• Actionable Insight: Investors must have a mechanism to “understand what is the current market Environment in which we are operating.”
• Consequences of Neglect: Failing to understand the market environment leads to mistakes in aggression levels and position sizing.
• Overall Message: “You should have a sense of in what environment am I operating and you know what and and what does it mean to the probability of my success in the current environment.”

1. Actual Surprise in Earnings: “An actual Improvement in…the earnings in a significant manner which forces the market to rate the stock.”

1. Anticipation of Earnings Surprise: “There is an anticipation that the earnings will surprise in a meaningful way.”

• Description: Often referred to as “story stocks” or “narrative-based stocks.” These stocks may outperform those with actual earnings due to psychological factors and the absence of hard data.
• Example: Adani Group rally, where stocks went up “5, 10, 15x, 20x” driven by anticipation rather than current numbers.
• Risk: Higher reward comes with “a lot of volatility and uncertainty” and requires a “different mindset and a different risk management policy.”

1. Big Jump in Revenues: A “meaningfully big jump in Revenue versus the last several quarters.”
2. Big Jump in Operating Profit: A “big jump in operating profits for the current quarter versus the last several quarters.” This is preferred over net profit due to potential “below the line” activities.
3. Expansion in Margins: This is crucial, as “Improvement in the margins gives rise to a huge operating leverage which eventually translates into a much Higher higher growth at the EPS level.”

1. Timing of the Jump: This must be the first or second quarter where such a significant jump occurs.

1. Sectoral Improvement: “Multiple companies the same sector are giving Blockbuster numbers.” This signals a real, broad-based trend (e.g., PSU Banks, IT companies).
2. Smaller Company: “Choose the smaller company because smaller companies make bigger moves.”
3. Recent IPO: Companies that have IPO’d in the last 2-3 years with good earnings are high-probability candidates due to “not a lot of ownership” and prior selling.
4. Low Float: “If the float is low it’s very easy for the buyers to take control,” leading to “very explosive moves” when combined with good news.

• Immediacy is Key: “You have to buy immediately post results.”
• Timeline:If results are overnight: Buy “within the first 30 minutes or 1 hour.”
• If results during market hours: Buy “at least within the next day.”
• Rationale: “These stocks can very quickly move up 20 30 40% before taking a pause.”

• Diversification Recommended: “Stay Diversified with this approach” with a portfolio of “20 25 stocks” to “20 to 30 stocks.”

• Concentration (for Skilled Investors Only): Possible “only during a bull market” if one is “skilled” and can implement a “proper logical stop-loss.”
• Logical Stop-Loss: “The stock should not come back to the price where it was there pre-results.” If it does, it implies the market isn’t validating the move.
• Diversified Investor’s Stop-Loss: A diversified investor “should not use any stop loss” because “diversification itself is a risk management exercise” and small/mid-cap corrections (15-20%) are normal.

• Hold as long as: “No news flow…that poses a risk to the earnings of the company.”
• Re-evaluate and Exit if:An event impacts the specific company’s earnings (e.g., raw material price increase for a chemical company).
• An event impacts the entire sector (e.g., government policy change).
• Core Thesis: The bet is that “this good quarter is going to continue.” If that thesis is jeopardized, re-evaluate.

1. Weakening Result Momentum: “The result momentum weakens considerably.”
2. Fourth or Fifth Quarter of Good Results: “Generally these rallies will finish in three or four quarters.” Sitting on significant profits, it’s time to book them as “the improvement has already taken place and the improvements cannot go on forever.” “Trees don’t grow to Sky.”
3. Results are “Too Good to Be True”: “If the results are so good and the margins are so high that it’s hard to significantly improve on the numbers.” This often happens in the second or third quarter (e.g., Fine Organics, Tata Elxsi). “Mean reversion is one of the…natural tendencies of the market.”
4. Significant Profits (Even if Other Conditions Not Met): “If none of these are qualified but you’re sitting on significant profits…you have to take some money off the table.”

Step 1: Use fundamental analysis to shortlist strong companies with good growth prospects.

Step 2: Apply technical analysis to time the entry (buying near support levels or breakouts) and exit (selling near resistance or trend reversals).

Step 3: Manage risk using stop-losses and position sizing based on technical signals.