For many investors, the approach of earnings season can bring fear and trepidation.
Sure, if a stock you happen to be in positively surprises and the stock shoots up, it can be an amazing feeling, not to mention a potentially spectacular win. There are very few things that can send a stock skyrocketing like a positive earnings surprise.
But, the flip side, which seems to happen far too often, is when a stock negatively surprises and your stock plummets. It can ruin a trade, set back an entire portfolio, and make a trader gun shy for many trades to come. Few things can decimate a stock like a negative earnings surprise.
It's no wonder so many investors are afraid of earnings season.
But it doesn't have to be that way.
Zacks Earnings ESP
Earnings season can feel like a crapshoot sometimes. Even the 'best' companies are not immune to posting a negative surprise.
But there is a way to significantly tilt the odds in your favor of being in stocks that positively surprise, and being out of stocks that negatively surprise.
And that's with Zacks Earnings ESP. The ESP stands for "Expected Surprise Prediction".
While nothing is 100%, our time tested Earnings ESP has 70% accuracy in predicting which stocks will positively surprise.
For the stocks that that fall outside of this range, 9% of those meet expectations, and the other 21% miss.
Being able to predict which stocks will positively surprise with a 70% accuracy can absolutely transform your portfolio.
What is an Earnings ESP?
The Earnings ESP uses Zacks proprietary methodology for determining the Most Accurate Estimate, and then compares that to the Zacks Consensus Estimate. The percentage difference between the two is the 'expected' surprise that Zacks is predicting the company will report come earnings time.
For example, if the Most Accurate Estimate (as determined by Zacks) for a company about to report is $1.25, while the full Zacks Consensus Estimate is $1.22; that’s a +3 cent difference for an expected surprise prediction (ESP) of 2.5%.
And 7 out of 10 times, the positive ESP will accurately predict a positive surprise.
The Earnings ESP works best when combined with the Zacks Rank.
Very simply, stocks with a Zacks Rank of a #1, #2, or #3 (Strong Buy, Buy, or Hold), with a positive Earnings ESP, are the ones that produce a positive surprise 70% of the time. This is an important combination.
If a stock has a positive Earnings ESP, but a Zacks Rank of a #4 or #5 (Sell, or Strong Sell), the chance of a positive surprise is diminished and the likelihood of a negative surprise increases.
Likewise, if a stock has a Zacks Rank of a #1, #2, or #3, but has a negative Earnings ESP, the chance of obtaining a positive surprise falls to little better than a coin flip at 52%.
Stick with stocks with a positive Earnings ESP and a Zacks Rank #1, #2, or #3 to increase your odds of success.
Maximizing Returns and Avoiding Pitfalls
Keep checking the Earnings ESP each day prior to the report. The ESP number, like anything, can change. They key, however, is to go into the report with a favorable Zacks Rank and a positive ESP.
Over a 10-year backtest, using a 1 week holding period, (stocks were held for no more than one week after they reported), the average annual return was 28.3%.
Investors can further maximize their returns by focusing on those stocks with higher ESP levels. For example, stocks with an Earnings ESP of at least 1% have shown an average annual return of 29.6%. An ESP of at least 2% bumps performance to 31.6%. And an ESP of greater than 3% brings it up to 37.2%.
But note, there's no need to hold out for stocks with big double or triple digit ESP's. While some stocks like that will do well, there's no aggregate increase in performance. And the number of stocks that qualify would shrink.
It should also be noted that the Earnings ESP is less effective at predicting which companies are likely to miss. Our research shows that if a stock has both a negative Earnings ESP and an unfavorable Zacks Rank of a #4 or #5, a negative surprise happens only 41.6% of the time.
While a negative ESP clearly suggests a greater likelihood of a negative earnings surprise, a positive ESP is a far more robust predictor of a positive surprise.
For this reason, it's best to concentrate only on stocks with a positive Earnings ESP and a favorable Zacks Rank to finds stocks most likely to outperform their earnings estimates.
Get Excited This Earnings Season
The next earnings season will soon be here.
That means nervousness, unease, and downright dread for many investors.
But for others, it's a time of excitement and high probability.
There's no special trick or magic involved in getting into stocks most likely to surprise. At Zacks, it comes down to a simple formula. Granted, it's a highly guarded, proprietary formula that we've spent years creating. But it's a mathematical formula nonetheless, and we make it available to zacks.com users, helping them trade every earnings season confidently and profitably.
This next earnings season make sure to use the Zacks Earnings ESP, and get yourself positioned into the stocks most likely to positively surprise.
For more on Earnings ESP, make sure to check out the links below, or go to any quote page to see that stock's current ESP metric.
Earnings ESP home page
Find stocks that are likely to beat earnings at their next report
See our list of Earnings ESP screens
Zacks Investment Research