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Should You Buy Stocks Going into This Earnings Season?

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Normally, we try to look for stocks that can jump on a positive print to lock in some quick gains.

But two factors are worth considering this time round-

The first and most obvious is the reset of estimates after easy beats in the last quarter. Analysts pulled down their estimates when the virus hit because they feared dismal quarterly results. But when companies didn’t do as bad as expected, estimates went up by 20%, 30% and in some cases as much as 80%. With estimates now at more realistic levels, earnings beats will be that much harder to achieve.

Second, the Zacks earnings Trends report indicates a 22.8% decline in third quarter 2020 earnings on 2.8% lower revenue (despite the reset). The forecast has been moving northward since July, which is a positive. But with that much of a negative outlook, do we really have reason to pin our hopes on the regular response to earnings?

Because this is not a normal year. It’s a year that has forced social distancing upon us so people are unable to engage in activity that generates commerce. With economic activity back-strapped by the virus, the broad availability of a vaccine still some way off, and social distancing playing nice with some sectors and not so nice with others, we’re practically down to guessing at what might happen this quarter.

But the Zacks system does offer some pointers.

So we have the Earnings Expected Surprise Prediction (ESP), which relies on the direction of most recent estimate revisions to determine the possibility of an earnings beat. It’s based on the idea that the most recent estimates include fresh information on what’s going on with the company.

In case you’re wondering about the efficacy of such a system, our 10-year back test shows a 70% accuracy rate, when the ESP is coupled with a Zacks Rank #3 (Hold) or higher.

The Zacks Rank is of course a pillar in its own right, having proved itself over the years. In general, we recommend stocks ranked #1 (Strong Buy) or #2 (Buy) while stocks ranked #4 (Sell) and #5 (Strong Sell) are not recommended.

Because there are usually some industry-specific factors that drive stocks and also share prices and because of the uneven nature of this recovery, it might be a good idea to also consider the particular industry in which a stock belongs. The top 50% of Zacks-classified industries typically outperforms the bottom 50% by a factor of more than 2 to 1.

Although not an imperative, it makes sense to take a look at the number of analysts covering the stock and their average recommendation because our ESP metric is based on their estimates. Three or more brokers and a rank of 2 or lower are preferable.

To check the track record, you could also take a look at the recent surprise history. That will give you an idea about whether the company usually beats estimates.

Finally, check for a positive growth outlook for this year.

Here are a few examples-

Lennar Corporation (LEN - Free Report)

With a Zacks Rank #1 and earnings ESP of 3.58, Lennar operates in the attractive Building Products - Home Builders industry (top 8%). The company topped estimates in each of the last four quarters at an average rate of 33.36%. It is currently expected to grow 25.4% this year. Average broker recommendation is 1.93.

Valuation: The shares are trading at a forward twelve months’ earnings multiple of 11.41X, which is between their median of 10.19X and high of 12.21X over the past year. S further upside is possible.

Activision Blizzard, Inc (ATVI - Free Report)

The company has a Zacks Rank #2 and Earnings ESP (variance between the Consensus Estimate and the most recent estimate) of 8.66. It belongs in the Toys - Games – Hobbies industry (top 32%). It has topped estimates in each of the last few quarters at an average rate of 30.47%. It is currently expected to grow 43.7% this year. Average broker recommendation is 1.34.

Valuation: The shares are trading at a P/E of 23.47X, which is below the median value of 26.05X over the past year. So they are undervalued/cheap.

Danaher Corporation (DHR - Free Report)

This Zacks Rank #2 company has an earnings ESP of 2.55. The Diversified Operations industry to which it belongs is in the top 39% of Zacks-classified industries. It has topped estimates in each of the last four quarters at an average rate of 10.83%. It is currently expected to grow 24.1% this year. Average broker recommendation is 1.31.

Valuation: The shares are trading at a P/E of 36.03X, which is closer to their annual high of 37.15X than the median of 29.94X over the past year. Although they appear a bit expensive, upwardly revised estimates can quickly change the situation.

Installed Building Products, Inc. (IBP - Free Report)

The company has a Zacks Rank #1 and earnings ESP of 1.72. It belongs to the Building Products – Miscellaneous industry, which is in the top 9% of Zacks-classified industries. It has topped estimates in each of the last four quarters at an average rate of 23.34%, It’s expected to grow 26.4% this year. Average broker recommendation is 1.90.

Valuation: The shares are trading at a P/E of 23.93X, which is between their median of 20.00X and annual high of 26.16X over the past year. So further upside is possible.

Asanko Gold Inc. (GAU - Free Report)

The company has a Zacks Rank #2 and earnings ESP of 33.33. It belongs to the Mining – Gold industry, which is in the top 37% of Zacks-classified industries. It has topped estimates in the last two quarters while missing in the preceding two quarters. However, the average four-quarter surprise is 125.0%, It’s expected to grow 2,200% this year. Average broker recommendation is 1.86.

Valuation: The shares are trading at a P/E multiple of 7.24X, which is below their median of 9.86X over the past year. So the shares are undervalued.

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