“There is only one side to the stock market; and it is not the bull side or the bear side, but the right side.” – Jesse Livermore

The market determines winners and losers.

The U.S. stock market has gotten off to a strong start in 2023 following a dreary bear market last year. After printing a series of lower lows, the major indices have altered their course, creating a pattern of higher lows and higher highs. This bullish reversal speaks to a change in the overall trend, and we will soon find out if the buying pressure can continue in the weeks and months ahead.

Whereas inflation was the big concern last year, markets have seemingly moved past the higher prices problem, as it appears the Fed’s aggressive rate-hiking scheme has allowed inflation to moderate. As the higher interest rate environment makes its way through the economy, the concern has shifted from inflation to a slowdown and potential recession. And with corporate earnings set to decline, it’s easy to be bearish from an investment standpoint – particularly after a year like last year.

But the financial markets are forward-looking, and they generally price in earnings declines well before they happen. That’s essentially what was happening last year. Stocks experienced large drawdowns in 2022 in anticipation of a downturn in 2023 (due in large part to the Fed tightening).

But by the time the actual earnings declines occur, stocks have already begun to discount future earnings cycles, enabling them to move higher given a brighter outlook. And as has been shown this season, if earnings come in even slightly above expectations, it can trigger powerful upside momentum for stocks going forward.

There’s nothing like higher prices to cause a change in sentiment, and we’ve seen that from the start of this year. Goldman Sachs recently cut its subjective probability that the U.S. economy will enter a recession in the next 12 months from 35% to 25%, which was less than half the 65% consensus estimate from the latest Wall Street Journal survey. And the bullishness may be likely to continue, as global fund managers reallocate from defensive positioning back to equities.

Assuming markets find their footing, the more aggressive pockets of the market that were beaten down last year should do very well. A renewed uptrend brings with it an intriguing possibility: incredible outperformance in 2023 from undervalued stocks.

How do we go about identifying these individual companies?

We can start by detecting leading industry groups. The Zacks Industry Group Rank makes this process easy for investors, classifying industries based on the earnings estimate revisions of the underlying stocks within each industry. So if the stocks within a given group are experiencing positive earnings revisions, that industry will receive a higher ranking. Let’s take a look at an example.

The Zacks Semiconductor Equipment – Material Services industry is ranked in the top 1% out of approximately 250 industries. Because it is ranked in the top half of all Zacks Ranked Industries, we expect this group to outperform over the next 3 to 6 months. Digging a bit deeper, this industry has begun to outperform this year (+28.2% YTD) versus the S&P 500 (+6.5% YTD).

Image Source: Zacks Investment Research

Quantitative research studies suggest about half of a stock’s future price appreciation is due to its industry grouping. By targeting stocks contained within leading industry groups, we can dramatically improve our odds of success. Also note the favorable characteristics for this group:

Image Source: Zacks Investment Research

Let’s take a deeper look at a highly-ranked stock within this leading industry.

ACM Research, Inc. (ACMR Quick QuoteACMR - Free Report)

ACM Research develops, manufactures, and sells single-wafer wet cleaning equipment for enhancing the manufacturing process and yield of integrated semiconductor chips. The company’s technology delivers megasonic energy at a microscopic level, providing cleaning for 2D and 3D patterned wavers. ACMR’s cleaning processes use less sulfuric acid and hydrogen peroxide, providing more efficient performance for advanced metal plating. ACM Research sells its products under the Ultra C brand name through direct sales forces and third-party representatives.

ACMR has put together a notable history of earnings surprises, surpassing earnings estimates in each of the last four quarters. The company most recently reported Q3 earnings back in November of $0.42/share, a 121.05% surprise over the $0.19 consensus estimate. ACMR has delivered a trailing four-quarter average earnings surprise of 220.73%.

ACMR stock has returned investors north of 60% already this year. Trading at just a 11.21 forward P/E, shares remain relatively undervalued despite the impressive move.

Image Source: Zacks Investment Research

Analysts covering ACMR have upped their 2023 EPS estimates by 94.74% over the past 60 days. The Zacks Consensus Estimate now stands at $1.11/share, reflecting potential growth of 50% relative to last year.

Image Source: Zacks Investment Research

Keep an eye on this leading stock as the outperformance looks set to continue.