Price Spikes and the Zacks Rank

Quite often stocks are designated Zacks #1 Rank after a run up in price. Although, price changes are not calculated as part of the Zacks Rank, events that typically cause a rise in share price also spur increases to the Zacks Rank.

When positive earnings news is released for a company, whether it be a bullish earnings report or a favorable news announcement, a stock can immediately jump in price. Depending on how quickly brokerage analysts revise their estimates, the Zacks Rank may not improve until a day or more after the news was released. This may make it seem that the Zacks Rank is a lagging indicator. Yet even with this slight time delay, we have proven since the inception of the Zacks Rank that these stocks continue to outperform the market over the next 1-3 months.

Here's why.

If a company announces a strong earnings outlook, then speculative investors often quickly react by bidding up the stock price. At the same time, analysts speak with the company's executives and revise their earnings estimates based on the new information. It may take the analysts up to a week to release their new estimates. Since the Zacks Rank is based on analysts' estimates, the Zacks Rank does not change until the new estimates are released by the analysts and added to Zacks' database.

Institutional investors receive the new brokerage reports at the same time as Zacks and factor the revised earnings estimates data into their valuation models. Based on the new data, these large investors perceive the stock as being undervalued relative to its revised growth prospects and decide to buy more shares. However, since institutional investors have so much money to spend, they gradually purchase the stock over a period of several weeks and months. (This is often described as "Accumulation").

Traders who rely on technical analysis (charting) notice the upward price movement and increase in volume for the stock caused by strong demand among institutional investors. These traders spot the trend and begin buying shares in hopes of generating short-term profits.

Our research and the +26% average annual return generated by Zacks #1 Rank stocks (many of which were upgraded to #1 Rank after the initial spike in price) shows that positive earnings revisions are often more than just one-time events. Rather, a company that reports a positive earnings surprise and experiences positive Earnings Estimate Revisions is likely to continue to do so in the future. And since the Earnings Estimate Revisions are the most powerful force impacting stock prices, the stock has a good chance of appreciating even more in the future.

Next: Why a Stock May Lose Its #1 Rank

Previous: Predicting Price Movement

Zacks Rank Guide Table of Contents

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