The uncertainty prior to an earnings release by a company stems from speculation over its beat potential. More than the comparison with previous results, it is a positive earnings surprise which drives the stock post release. And since in any earnings season, both positive and negative surprises hit us, investors must always be looking keenly for stocks likely to post positive surprises or an earnings beat.
Why Is a Positive Earnings Surprise So Important?
Historically, stocks of companies with solid quarterly earnings (on a nominal basis) tank if they miss or merely meet market expectations. After all, a 20% earnings rise (though apparently looks good) doesn’t tell you if it has been decelerating.
Also, seasonal fluctuations can come into play. If a company’s Q1 is seasonally weak and Q4 is strong, it is likely to report a sequential earnings decline. In such cases, growth rates are misleading while judging the true health of a company.
On the other hand, after a whole lot of research and analysis on a company’s financials and initiatives, Wall Street analysts project its earnings. They also take a company’s guidance into consideration when deriving an earnings estimate.
Thus, outperforming that estimate is almost equivalent to beating the company’s own expectation as well as the market perception. And if the margin of earnings surprise is big, it typically drives the stock higher right after the release. Thus, more than anything else, an earnings surprise can push a stock higher.
How to Locate Potential Outperformers?
Now, finding stocks that have the potential to beat on the bottom line is a dream that investors chase but might not always come true. One way of fulfilling it is by looking at the earnings surprise history of a company.
An impressive track in this regard generally acts as a driver in sending a stock higher. It indicates the company’s ability to exceed estimates. And investors generally believe that the company will have the same trick up its sleeve to deliver yet another earning beat in its upcoming release.
The Winning Strategy
In order to shortlist stocks that are likely to come up with an earnings surprise, we chose the following as our primary screening parameters.
Last EPS Surprise greater than or equal to 10%: Stocks delivering positive surprise in the last quarter tend to surprise again. Average EPS Surprise in the last four quarters greater than 20%: We lifted the bar for outperformance slight higher by setting the average earnings surprise for the last four quarters at 20%. Average EPS Surprise in the last two quarters greater than 20%: This points to a more consistent surprise history and makes the case for another surprise even stronger.
In addition, we place a few other criteria that push up the chance of a positive surprise.
Zacks Rank less than or equal to 2: Only companies with a Zacks Rank #1 (Strong Buy) or 2 (Buy) rating can get through. A stock needs to have both a positive Earnings ESP and a Zacks Rank of #1, 2 or 3 for an earnings beat to happen, as per our proven model. Earnings ESP greater than zero:
In order to zero in on those that have long-term growth potential and high trading liquidity we have added the following parameters too:
Next 3–5 Years Estimated EPS Growth (Per Year) greater than 10%: Solid expected earnings growth exhibits the stock’s long-term growth prospects. Average 20-day Volume greater than 100,000: High trading volume implies that the stocks have adequate liquidity.
A handful of criteria narrowed down the universe from more than 7,700 stocks to 16.
Here are five out of 16 stocks that passed the screen:
Activision Blizzard Inc ( ATVI Quick Quote ATVI - Free Report) ): The company is a leading developer and publisher of console, online and mobile games. It has a Zacks Rank #2. You can see . the complete list of today’s Zacks #1 Rank stocks here Brinker International Inc. ( EAT Quick Quote EAT - Free Report) ):The Zacks Rank #1 company owns, operates, develops and franchises various restaurants under Chili’s Grill & Bar (Chili’s) and Maggiano’s Little Italy (Maggiano’s) brands. Hologic Inc. ( HOLX Quick Quote HOLX - Free Report) ): The Zacks Rank #1 companydevelops, manufactures, and supplies diagnostics, medical imaging systems and surgical products which cater to the healthcare needs of women. Lennar Corporation ( LEN Quick Quote LEN - Free Report) ):The Zacks Rank #1 company is engaged in homebuilding and financial services in the United States. The company’s reportable segments consist of Homebuilding, Lennar Financial Services, Rialto and Lennar Multifamily. SunPower Corporation ( SPWR Quick Quote SPWR - Free Report) ):The Zacks Rank #2 company is engaged in designing, developing, manufacturing, markets and selling high-performance solar electric power technology products, systems and services worldwide to residential, commercial and utility-scale power plant customers.
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Disclosure: Performance information for Zacks’ portfolios and strategies are available at: . https://www.zacks.com/performance