Tapping stocks that come up with solid earnings is a common practice. But instead of picking such stocks post earnings, investing in those that are likely to beat market expectations may increase your gains manifold. Why Is a Positive Earnings Surprise So Important? Historically, stocks of companies with solid quarterly earnings (on a nominal basis) fall if they miss or just meet market expectations. After all, a 20% earnings rise (though it looks good apparently) doesn’t tell you if earnings growth has been exhibiting a decelerating trend. If that is the case, the company’s fundamentals are in question. There is also the factor of seasonal fluctuation. 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 ambiguous while judging the company’s true health. Meanwhile, Wall Street analysts study companies’ financials and initiatives to forecast earnings. They in fact club their insights and the company’s guidance to arrive at an earnings estimate. So, outperforming that estimate is almost equivalent to beating the company’s own expectation as well as market perception. And if the company manages to surpass earnings by a wide margin, it typically drives the stock higher right after the release. How to Find Those Gems? Since it is hard to predict if a company will beat or miss in the upcoming earnings season, investors can check its earnings surprise history. A notable track record generally acts as a tailwind. It revs up chances of beating estimates in the next release too as investors expect the company to use the same old trick to surpass expectations, or is smart enough to pull off a beat in the next 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. Here are five of the 25 stocks that passed the screen: Sanderson Farms Inc. ( SAFM Quick Quote SAFM - Free Report) : The company is a poultry processing company that produces, processes, markets and distributes fresh and frozen chicken products. It has a Zacks Rank #1. TakeTwo Interactive Software Inc. ( TTWO Quick Quote TTWO - Free Report) ): It is a leading developer and publisher of video games. It carries a Zacks Rank #2. Caterpillar Inc. ( CAT Quick Quote CAT - Free Report) ): The company is the largest global manufacturer of construction and mining equipment. The stock has a Zacks Rank #2. D.R. Horton Inc. ( DHI Quick Quote DHI - Free Report) ): This Zacks Rank #2 company is one of the leading national homebuilders, primarily engaged in the construction and sale of single-family houses, both in the entry-level and move-up markets. Align Technology Inc. ( ALGN Quick Quote ALGN - Free Report) : The Zacks Rank #1 company manufactures and markets a system of clear aligner therapy, intra-oral scanners and CAD/CAM (computer-aided design and computer-aided manufacturing) digital services used in dentistry, orthodontics, and dental records storage. You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and test them first before taking the investment plunge. The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out. . Click here to sign up for a free trial to the Research Wizard today 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