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The Q2 earnings season has officially begun and is well on its way with about 40 S&P 500 companies reporting.

By late last week, 29 of S&P 500 members had reported results and maintained the market’s mixed picture which is similar to we saw in Q1. Earnings and revenue growth for these 29 companies are comparable to what these same companies achieved in Q1 2013, but the beat ratios (% of companies coming out with positive surprises) are modestly weaker on the earnings side and about the same on the revenue side.

Over the last couple days, financials stole the show and have really stood out as the big winners giving the equity market a boost.  Earnings from the likes of J.P. Morgan (JPM - Analyst Report), Wells Fargo (WFC - Analyst Report) (both big winners mentioned in last week’s ESP article), Citigroup C and Goldman’s  (GS - Analyst Report) blowout report today are adding some bullish fuel to the fire.

Bernanke is on deck with his house testimony beginning tomorrow as well as earnings from Bank of America, PNC Bank, Intel, IBM Corp., eBay and many more.

Stocks are going to have a ton to digest in the coming weeks, volatility is sure to remain elevated so make sure you’re prepared!

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
Rambus Inc ((RMBS - Snapshot Report)is a Zacks Rank #1 stock with a positive earnings ESP of 9.09% for the current quarter.  The company is expected to lose 11 cents a share, but our ESP readings are looking for a smaller loss of  10 cents.

Rambus recently won back an important patent dispute in appeals court.  On that news, shares have nearly doubled.  Rambus is expected to continue to turn its business around and move back into the black by 2014.

There is no doubt that this is a higher risk stock with its recent rally and spotty financials.  But if Rambus can not only beat this quarter, but offer some strong guidance for the future, shares could march higher.

– Rambus reports earnings on July 18th

Capital One Financial ((COF - Analyst Report)) is a Zacks Rank #2 stock with a positive earnings ESP of 1.2% for the current quarter; the Zacks Consensus is for a per share profit of $1.72, with the most accurate at $1.74.

What’s in your wallet?  

Investors are thinking that there’s a wad of cash in Capital One’s apparently; at least relatively speaking.

Despite a small rise in delinquency rates on loans held at COF, analysts on average are bullish going into the report and have been moving their estimates higher over the last 2 months.

Financials have been a bright spot in this otherwise drab earnings season and hopefully we will see the same from COF, although risks may be a slightly elevated, it still trades at just 10 times forward earnings; well within the sector’s average range.

– Capital One reports earnings on July 18th

American Electric Power ((AEP - Analyst Report)) is a Zacks Rank #3 stock with a positive earnings ESP of 5.00% for the current quarter.  The Zacks Consensus Estimate is for a profit of $0.80 this quarter and the most accurate consensus comes in at a profit of $0.84.

American Electric Power is a public utility holding company that throws off a modest dividend yield of 4.15%. Substantially all of the operating revenues of AEP and its subsidiaries are derived from the furnishing of electric service.

Coming into the report, shares are trading at 14.76 times forward earnings; analysts are looking for 3.56% in earnings growth on a 1.5% increase in revenue in 2013.  AEP rallied last quarter on a very similar earnings expectation. This time around, valuations and stock price seem even more favorable.

– AEP reports earnings on July 19th

ESP Earnings Techniques
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 and trades sent directly 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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