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Investment Ideas

Alcoa (AA - Analyst Report) unofficially kicked off earnings season yesterday with a decent report.  The Aluminum giant actually came in line with the Zacks Consensus of 7 cents and came up slightly short on the revenue side.  The report was initially viewed with a positive light due to the increase in aluminum demand Alcoa was seeing.

That said, shares of Alcoa moved lower today after investors had time to examine the details.

It’s important to note that the earnings bar remains extremely low and has come down substantially over the last quarter from close to 4% year over year growth to now just 0.3%.

Even with the low expectations, it will be challenging to find companies that beat earnings estimates especially being that revenues are down year over year and the global consumer is barely hanging on.

One bright spot for growth may be the financial space; our Director of Research, Sheraz Mian noted this in a note to investors HERE.  The three financial stocks below all have increased probability of a beat with their positive ESPs, but are certainly not the strongest ESP stocks that I have seen. 

As we continue our search for stocks that have a high likelihood of beating estimates, the Zacks Earnings ESP can be an invaluable tool in your search.  Here are a few companies that look promising next week:

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

J.P. Morgan ((JPM - Analyst Report)) is a Zacks Rank #2 (buy) stock with a positive earnings ESP of 2.82% for the current quarter.  The company is expected to make $1.42 cents a share, but our ESP readings are looking for a profit of $1.46 cents.

JPM has been looking strong over the last week or so and shares are approaching the 52 week high of $55.90 going into the report.

With a valuation of just 9 times forward earnings and a man like Jamie Dimon at the helm, analysts seem to be looking for a beat from this financial giant on Friday.

– JP Morgan reports earnings on July 12th

Wells Fargo & Co. ((WFC - Analyst Report)) is a Zacks Rank #3 stock with a positive earnings ESP of 1.10% for the current quarter; the Zacks Consensus is for a per share profit of $0.92, with the most accurate at $0.93.

Wells Fargo is the largest loan originator in the U.S. and their earnings calls are always good information for the direction of the housing market.

Given the rise in home values and relative strength in new and existing home sales, it should be a good quarter  for Wells.   Of course, a rising interest rate has pros and cons for banks of their size, but the overall analyst consensus seems to be quite positive.

The majority of analyst action has been bullish and we have seen estimates on the rise for the current quarter, next quarter as well as FY 2013 and FY 2014 since WFC’s last report.  It’s important to note that despite the positive analyst actions, ESPs are mixed looking forward in time as the future of housing is still a little murky.

– Wells Fargo reports earnings on July 12th

TD Ameritrade (AMTD - Analyst Report) is a Zacks Rank #2 stock with a positive earnings ESP of 3.23% for the current quarter.  The Zacks consensus estimate is for Q1 EPS of $0.31 with the most accurate estimate coming in at $0.32.

Reuters recently published a story about the rising popularity of “hobby trading” by baby boomers, mainly in options and stocks which would certainly benefit companies like AMTD.  

TD Ameritrade has also been seeing positive analyst flow over the last 2 months leading into their report next week, which is usually a good sign for stocks looking to beat.

Shares are trading at 23 times forward earnings.

– AMTD reports earnings on July 23rd

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%.

If you require your stocks to have an ESP of greater than 1%, we found it increased 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.

Start Using Zacks ESP in Your Own Trading Today
The next time your stock is about to report or a stock on your watch list is getting closer to their earnings date, be sure to look at its Zacks ESP and see what your stock’s probabilities are of producing a positive surprise.

If you prefer to let someone else do all the work and have the best candidates sent to your inbox, learn more about Whisper Trader now.

Jared A Levy is one of the most highly sought after traders in the world and a former member of three major stock exchanges. That is why you will frequently see him appear on Fox Business, CNBC and Bloomberg providing his timely insights to other investors. He has written and published two tomes, “Your Options Handbook” and “The Bloomberg Visual Guide to Options”.  You can discover more of his insights and recommendations through his two portfolio recommendation services:

Follow Jared A Levy on twitter @jaredalevy

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