The earnings season is underway and all attention is on upbeat releases for some respite from the adverse impact of coronavirus. This means that the estimate-beating stocks will be the most important ones from the investment point of view.
Note that investors are always in the hunt for estimate-beating stocks before an earnings release. This is because investors always try to place themselves ahead of time and look to play stocks that are rich in quality and have high chances of beating earnings estimates.
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 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 over 7,700 stocks to 19.
Here are five out of 19 stocks that passed the screen:
Sanderson Farms Inc. ( SAFM Quick Quote SAFM - Free Report) : The Zacks Rank #1 company is a poultry processing company that produces, processes, markets and distributes fresh and frozen chicken products.You can see the complete list of today’s Zacks #1 Rank stocks here. Dow Inc. ( DOW Quick Quote DOW - Free Report) ): The Zacks Rank #2 material science company provides a portfolio of advanced, sustainable and leading-edge products. The company Zacks Rank #2. FedEx Corporation ( FDX Quick Quote FDX - Free Report) ): FedEx is the leader in global express delivery services. It carries a Zacks Rank #2. Toll Brothers Inc. ( TOL Quick Quote TOL - Free Report) ): The Zacks Rank #2 company builds single-family home communities; master planned luxury residential resort-style golf communities; and urban low, mid, and high-rise communities, principally on the land it develops and improves. CBRE Group Inc. ( CBRE Quick Quote CBRE - Free Report) ): This Zacks Rank #2 commercial real estate services and investment firm offers a wide range of services to tenants, owners, lenders and investors in office, retail, industrial, multi-family and other types of commercial real estates in all major metropolitan areas across the globe.
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