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Macro View

Q4 season officially begins this week with the release of Alcoa’s numbers tomorrow morning. Even with Sandy, the election, the fiscal cliff and the lingering deficit issues, the market has been extremely resilient. So much so that the S&P 500 has risen over 8% since the November lows, which were hit just as Q3 earnings season was winding down.

What’s interesting is that in that time, the total fourth-quarter operating earnings estimate for the S&P 500 has fallen to $25.29 a share from $26.87; the S&P earned $23.73 in Q4-2012. These new expectations represent an almost 50% decrease in year over year Q4 earnings growth from 13.2% to an expected 6.6% in Q4.

One would think that with those revisions we would move markets lower, but obviously there is still hope that the U.S. will continue its slow grind higher; economic data somewhat supports this thesis. It’s also important to note that the fourth quarter does looks to be a better earnings season than the third quarter, where earnings for the S&P 500 were down slightly year-over-year, breaking an 11-quarter streak of EPS gains.

Finding stocks with the best chances of winning could be the best path to finding rising stock prices after earnings especially in uncertain times and the Zacks Earnings Surprise Prediction or ESP helps target those stocks.

About Zacks Earnings ESP
Earnings ESP is Zacks’ proprietary methodology for determining which stocks have the best chance to surprise with their next earnings announcement. The Earnings ESP shows the percentage difference between the Most Accurate Estimate and the Consensus. The Zacks ESP helps predict earnings surprises to the upside and downside; the greater the ESP (positive or negative) the greater the likelihood for a surprise. I use ESP to help quantify the conviction of the analysts for a surprise and stack the odds in my favor when I combine it with other measurements and statistics.

The Accuracy of ESP
Of course, some ESP numbers are better than others. In our testing, over the last 10 years, we have found that stocks with a positive ESP and with a Zacks Rank of 1, 2 or 3 (Strong Buy, Buy or Hold), produced a positive surprise 70% of the time.

(The other 9% of the time, they reported in line with expectations, with a negative surprise occurring only 21% of the time.)

Bullish ESP Stocks
Texas Industries ((TXI - Snapshot Report))is a Zacks Rank 3 stock with a positive earnings ESP of 26.47% for the current quarter. The company is expected to lose 34 cents a share, but our ESP readings are looking for a loss of only 25 cents.

As the U.S. continues to slowly recover, we need to turn our attention to our deteriorating infrastructure that is in dire need of repair. TXI focuses most of its energy on Texas and California which both lead the nation in federal highway funding.

With an ever growing populous and recovery underway in both states, TXI should stand to benefit. TXI has been struggling with sales, but are expected to begin growing earnings in the coming quarters.

– Texas Industries reports earnings on January 9th.

eBay ((EBAY - Analyst Report) - Analyst Report))is a Zacks Rank 2 stock with a positive earnings ESP of 6.52% for the current quarter; the Zacks Consensus is for a per share profit of $0.46.

Retail is getting mixed reviews for Q4, but eBay is in its own subsector as mainly an auction site, but with regular sale type items as well. Amazon was recently given an upgrade by Morgan Stanley, which may mean that confidence hasn’t been all lost on the sector.

Shares are relativity rich at almost 22 times forward earnings, but if eBay can deliver 13%+ growth, that multiple may be justified. There was a recent flurry of bullish analyst movements ahead of their report in a week. No analysts have lowered their estimates in the last 30 days.

– eBay reports earnings on January 16th.

Fifth Third Bancorp (FITB - Analyst Report) - Analyst Report)is a Zacks Rank 3 stock with a positive earnings ESP of 3% for the current quarter. The Zacks consensus estimate is for Q3 EPS of $0.42, with the most accurate estimate at $0.435.

Banks and financials are expected to be the shining light in a market with a mostly cloudy forecast.

Several analysts have noted positive developments in the sector; and while Raymond James downgraded FITB from a strong buy to an outperform, their price target on the stock still remains 13% higher than the current price.

The majority of analysts are at least moderately bullish on the name going into their next report.

– Fifth Third reports earnings on January 17th.

ESP Earnings Results
Now that you know which groups of stocks to focus on to increase your chances of a positive surprise, let’s look at the size of the ESP that has historically generated the best results.

First, just having a positive ESP produces market beating results. Over the last 10 years, using a 1 week holding period (stocks were held for no more than one week after they reported), the average annual return was 23.5%. This is in stark contrast to stocks with a negative ESP which produced a -9.20% return.

Now apply the Zacks Rank of 1, 2 or 3 to that list and the returns jump to 28.3%.

But requiring your stocks to have an ESP of greater than 1%, increases its performance to 29.6%. An ESP of greater than 2%, bumps performance up to 31.6%. While an ESP of greater than 3%, produces an average annual return of 37.2%.

Note: there’s no need to hold out for stocks with significantly higher ESP’s than 3%. While some stocks with higher ESP’s will do fantastic, there’s no aggregate increase in performance by ratcheting it up beyond d the 3% threshold. And as the above stats illustrate, simply having a positive ESP (i.e., the Most Accurate Estimate is above the Consensus) still produces stellar results with a high probability of success.


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