Not All Surprises are Made EqualAugust 21, 2009 | Comments : 0 Recommended this article: (0)
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Don't you love positive earnings surprises that make your stocks jump higher?
Don't you hate positive earnings surprises that, for some crazy reason, lead to the stocks tumbling down?
If you're like most investors, you probably had some stocks that rallied in response to earnings and a few that gave you a big headache as they tumbled. So, how do you make sense of it? And what do you do with those stocks that beat second-quarter expectations, but burned a hole in your brokerage account?
It's All About The Future
The reason earnings reports ignite a big move upward for some stocks and big move downward for others is a change in sentiment. A stock's price is ultimately dependant on how much money the company will earn in the future, not what it did in the past.
Therefore, a positive earnings surprise is only really good if it causes investors to be more optimistic about the quarters ahead. In other words, it's the quality of earnings that really matter.
How to Tell If Earnings Are Really Good
The most obvious way to tell if profits are good is to read the quarterly earnings release. But do you really have the time to read through every press release? Better yet, do you have the tolerance to put up with corporate lingo and spin like "commitment to fiscal discipline"?
I'm guessing that you probably have better things to do with your time. So, you look for a headline about whether or not the company beat expectations and then call up a stock quote. If the company beat, then the price should be higher, right?
Sometimes that just isn't the case. Take Symantec, for instance. The company beat by 2 cents with profits of 34 cents. The CEO even said that the company "laid the groundwork to drive improved execution in the second half". Sounds good, right?
Well, not exactly. Had you bought the stock right before its earnings release, you would have lost 12%. That's a big drop in a short period of time, and it was caused by a more dire outlook for the remainder of the current fiscal year and the next. But, you probably wouldn't have known without truly crunching the numbers.
A Better Way To Analyze Earnings
Fortunately, you don't have to spend hours poring over earnings press releases. There are thousands of professionals who are already paid to do this. They're called brokerage analysts and you can access their reports by opening accounts at about 150 brokerage firms.
Okay, that's not realistic is it? But what if you could easily tap their expertise? And what if you could do this quickly and easily? Would you do it?
I'm going to let you in on a little secret. All you need to do to profit from their forecasts is see whether a stock is a Zacks #1 Rank (good) or a Zacks #5 Rank (bad).
How is this possible? Simple. We receive updated research reports from more than 150 brokerage firms. We then combine all of that information into the Zacks Consensus Estimate - a forecast of what the company will earn in the future.
And here's the really big thing, it doesn't matter what the Zacks Consensus Estimate is, but rather if it is higher (good) or lower (bad) than it was before. If a company delivers a true earnings surprise, then analysts will revise their profit forecasts higher. If analysts fear that business conditions will worsen in the future, they will lower their profit forecasts.
Following the trends in earnings estimate revisions leads to very big returns. Since 1988, Zacks #1 Rank ("strong buy") stocks have generated a 27% annual return and Zacks #2 Rank ("buy") stocks have generated an 18% annual return. Conversely, you'd be better off putting your money in a savings account than owning Zacks #5 Rank ("strong sell") stocks.
It takes just a few seconds to harness the power of the earnings estimates revisions; you just need to check out the Zacks Rank. No hours of reading through earnings press releases. No painstaking analysis of financial statements. Just look at the Zacks Rank and profit. It doesn't get any easier.
So, I invite you to take a free trial to Zacks Premium, which includes full access to the Zacks Rank for your stocks. Also you can see all the stocks that got the highest grades this earnings season and are set to outperform.
More about Zacks Premium Free Trial
Wishing you prosperity,
Charles Rotblut, CFA
Charles is our Senior Market Analyst. He’s a world-class expert on industry trends and runs the Industry Analysis section on Zacks.com. He also heads the Zacks.com analyst team that generates picks for many of our trading services using Zacks Premium research.
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