Stocks with rising earnings estimate revisions are more likely to go up, while stocks with falling earnings estimate revisions are more likely to go down.
This makes sense on many levels. As analysts' outlook for a company's earnings improve, they raise their forecast for what the company will ultimately report.
As these earnings estimates rise, the stock would be under its fair value if it didn't rise along with it.
Institutional investors, many of which practice classical valuation modeling that includes fair value analysis, will buy those stocks with rising earnings estimates as the fair value of the stock points to higher prices.
Addus HomeCare Corp. (ADUS - Snapshot Report)
After posting a positive EPS surprise on March 13th, 2013, ADUS quickly earned the coveted Zacks Rank #1 (Strong Buy) two days later on March 15th, letting investors know that ADUS was ready to outperform and it was time to get in.
Within three short weeks, ADUS received just as many upward earnings estimate revisions, sending prices up more than 24% over that same time. For those who got in when the Zacks Rank #1 signal was first given, they built up a nice cushion of profits as they waited for the stock to continue tracking earnings estimates higher.
Some investors, after gaining a quick profit of 24% in such a short amount of time, might have been inclined to take those profits off the table, especially after prices drifted a bit lower over the following three weeks. This is a very common reaction. Who wouldn't want to lock in gains like that?
But investors who know about the power of earnings estimate revisions could literally see that there was more upside to come, as long as earnings estimate revisions continued to move higher. And move higher they did.
Note: each estimate revision doesn't have to be huge. Granted, those are fun to watch. And it feels great. But, the simple steady stream of upward estimate revisions shows analysts confidently increasing their outlook on the stock. And with each upward estimate revision, the stock builds up more and more reason to move higher as its fair value moves up as well.
After a series of five more upward revisions (nine upward revisions in a row), ADUS resumed its uptrend in earnest as it played catch-up with the improved earnings outlook, ultimately rewarding investors with a 69.24% increase in less than 2 ½ months. A significant outperformance, especially when compared to the S&Ps 4.49% over than same period.
The Zacks Rank is rooted in pure science and mathematical calculations. There is no subjectivity involved. The Zacks Rank is completely derived through the analysis of earnings estimates and earnings estimate revisions.
The best part however is that you don't need to turn yourself into an analyst to take advantage of the Zacks Rank. Just follow the trajectory of earnings estimate revisions to discover those stocks with the highest probability of going up. And get out of those stocks whose earnings estimates are going down.
And the easiest way to find stocks that have these characteristics is to follow their Zacks Rank. At a glance, the Zacks Rank will show you which stocks to buy, and which stocks to avoid.
Click here to find more Zacks Rank #1s (Strong Buys)
Disclosure: Performance information for Zacks portfolios and strategies are available at: http://www.zacks.com/performance.