Investors’ feverish search for earnings beat is quite understandable, especially as the second-quarter reporting cycle is wrapping up. Investors love an earnings beat because it usually always translates into stock price appreciation. In fact, a beat works better than earnings growth in this regard. We’ll tell you why.
What Makes Earnings Beat So Intriguing?
Historically, stocks of companies with solid quarterly earnings (on a nominal basis) fall if they miss or just come in line with 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 raise serious doubts.
Also, seasonal fluctuations are crucial in determining a company’s earnings growth. If a company’s Q1 is seasonally weak and its Q4 is strong, it is likely to report a sequential earnings decline in Q1. In such cases, growth rates are misleading when it comes to analyzing the true picture of a company.
On the other hand, Wall Street analysts rack their brains to study companies’ financials and initiatives to forecast earnings. They in fact club their insights and the company’s guidance to derive an earnings estimate.
Thus, beating this key number is almost equivalent to beating the company’s own expectation as well as the market perception. And if the margin of surprise is big, it typically drives the stock higher right after the release.
Now, since it is difficult to foretell if a company will beat or miss in the upcoming earnings season, investors can check its earnings surprise history. An impressive track record generally acts as a catalyst, sending the stock higher. It proves the company’s ability to surpass estimates. And investors generally believe that the company will have the same trick up its sleeve or, in other words, is smart enough to beat on earnings in its next release as well.
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 slightly higher by setting the average EPS 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 surprise.
Zacks Rank less than or equal to 2: Only companies with a Zacks Rank of #1 (Strong Buy) or 2 (Buy) can get through. Earnings ESP greater than zero: A stock needs to have both a positive Earnings ESP and a Zacks Rank of #1, 2 or 3 (Hold) for an earnings beat to happen, as per our proven model.
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 has narrowed down the universe from over 7,700 stocks to around 23.
Here are the five stocks that passed the screen:
Under Armour Inc. ( UAA Quick Quote UAA - Free Report) : The company is one of the leading designers, marketers, and distributors of authentic athletic footwear, apparel, and accessories for a wide variety of sports and fitness activities in the United States and internationally. It has a Zacks Rank #2. You can see . the complete list of today’s Zacks #1 Rank stocks here Deere & Company ( DE Quick Quote DE - Free Report) ): The company is the world’s largest producer of agricultural equipment, manufacturing agricultural machinery since 1837 under the iconic John Deere brand with its signature green and yellow color scheme. It has a Zacks Rank #2. Ulta Beauty Inc. ( ULTA Quick Quote ULTA - Free Report) ): Peviously known as Ulta Salon, Cosmetics & Fragrance, Inc., it is a leading beauty retailer in the United States. The company carries a Zacks Rank #2. Selective Insurance Group Inc. ( SIGI Quick Quote SIGI - Free Report) ): The company operates as a P&C insurer. It offers insurance products and services across the United States andsports a Zacks Rank #2. Jack In The Box Inc. ( JACK Quick Quote JACK - Free Report) : It is a restaurant company that operates and franchises through Jack in the Box quick-service restaurants, and is one of the nation’s largest hamburger chains.. The stock has a Zacks Rank #2.
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. 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