Fourth-quarter earnings season has started to ramp up, with results already out from more than 12% of the S&P 500. This means now is a great time to try to find stocks that look poised to benefit from an earnings-season boost. And today we picked a screen that works well both before and after a company reports their quarterly financial results.
Every earnings season features positive and negative surprises on both the top and the bottom lines.Therefore, our screen focuses on earnings and revenue surprises because investors should pay close attention to both metrics.
Before we dive into the screen, let’s quickly go over the basic principles. In general, if a company reports quarterly earnings above expectations it is considered a positive surprise, and the firm’s stock price often climbs. On the other hand, a company reports a negative surprise if it falls short of bottom-line estimates, and the prices generally should go down.
With that said, a surprise represents far more than just an extra few dollars or cents a company made or lost during the period. It is instead a look into what a company’s earnings might be or should be, down the road.
Investors should also note that when these surprises occur, the market quickly tries to re-price the stock to reflect the new information.
Not All Surprises Are Created Equal
It might seem intuitive, but it is still worth diving into the differences between surprises. For starters, some earnings surprises can be attributed to cost-cutting measures and others are due to revenue jumps.
Sales growth often produces a larger price reaction compared to its money-saving counterpart because revenue growth is viewed as more sustainable. The reasoning is straightforward: once a company has cut costs, where is its future growth going to come from? Firms can only cut so many costs. Meanwhile, sales growth is one of the most vital components of long-term growth.
Along with earnings and revenue results, investors also need to pay attention to guidance. If a company reports a positive surprise and downward guidance it will often cause negative stock price movement since the firm diminished the hope of the future growth that comes with a positive surprise.
We also need to pay close attention to financial results that are not truly “surprises.” For instance, companies that always beat their estimates, or stocks that have already had a “surprise” priced in by climbing or falling before an announcement. These situations might not be treated as surprises at all. In fact, in some cases, we can see the opposite reaction to an earnings surprise, known as “buy the rumor, sell the fact” type events.
With all that said, predicting which companies will surprise one way or the other is difficult. The benefits, however, of an earnings surprise will typically last for one to three months after a surprise is reported.
This means you can get in after a company reports a surprise, or you can try and find companies that are more likely to report a surprise, and get in ahead of time.
The screen I'm running today starts with:
• Last EPS Surprise greater than or equal to 5%
(Stocks posting positive surprises have a tendency of surprising again.)
• Last Sales Surprise greater than or equal to 5%
(A positive sales surprise shows top line strength. And once again, a company that has surprised in the past is more likely to surprise again in the future.)
• Zacks Rank less than or equal to 2
(Only Zacks Rank 1 and 2 Strong Buys and Buys can get thru.)
• Price greater than or equal to $5 and Average 20-day Volume greater than or equal to 100,000
Just these few criteria help narrow down the universe from over 8,800 stocks to just over 80.
Here are 5 stocks that meet today’s criteria:
iRobot Corporation (IRBT - Free Report) - (set to report on 02/06)
Planet Fitness, Inc. (PLNT - Free Report) - (set to report on 02/28)
Five9, Inc. (FIVN - Free Report) - (set to report on 02/20)
Twitter, Inc. (TWTR - Free Report) - (set to report on 02/07)
Chegg, Inc. (CHGG - Free Report) - (set to report on 02/11)
All of these companies reported both earnings surprises and sales surprises their last time out. A great combination. And we could see more of the same this time around as well.
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Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.
Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance/.
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