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Becoming A Better Investor Can Change Your Life

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We’ve all heard people say that becoming a better investor can change your life.

While it’s a great catch phrase, I don’t think anybody really stops to think about it, let alone believes it.

But it’s true.

Becoming a better investor can change your life.

For example: since 1988, the Zacks Rank #1 Strong Buy stocks have beaten the market in 28 of the last 34 years with an average annual return of 25.37% per year. That's more than 2 x the S&P’s 11.48%. And an annual win ratio of more than 82%.

That includes 3 bear markets and 4 recessions.

And being able to do this year after year, over and over again, can add up to a lot more than just 2 x the S&P.

While we can’t go back in time, let’s look at two investors over the next 10 years.

One is able to earn the average Zacks Rank #1 return of 25.4% per year, while the other earns the average 11.5% return of the S&P.

At 25.4%, a $100,000 investment, over the next 10 years, would show a compounded return of over 859%. That $100,000 would have grown into over $959,000.

At only 11.5%, that $100,000 would’ve compounded into just 196%, increasing to only $296,000.

At 15 years, that’s $2.9 million vs. $510K.

And at 20 years, that’s $9.2 million vs. $879K.

Becoming a better investor can change your life.

Just ask the guy who’s going to retire on $879,000 vs. the guy who’s going to retire on $9.2 million, and tell me that the guy with $9.2 million isn’t living a different life than the guy with $879K.

Now imagine, you’re not even earning market returns. Sadly, too many investors aren’t even coming close to that.

Becoming a better investor can, indeed, change your life!

Earnings Estimate Revisions and Stock Prices

Great. So now what?

How do you become a better investor?

The first step is to focus on stocks with upward earnings estimate revisions.

Why?

Because studies have shown that earnings estimate revisions are the most powerful force impacting stock prices.

Simply put, stocks with rising earnings estimates, as a group, have outperformed the S&P 500 year after year. And stocks with falling earnings estimates have underperformed the S&P year after year.

This means that the stocks most likely to outperform are the ones whose earnings estimates are being raised. And the stocks most likely to underperform are the ones whose earnings estimates are being lowered.

For example, let’s say an analyst believes a company will earn $1.00 per share in earnings ($1 estimated EPS). If the P/E ratio is 20 (20 x earnings), then the fair value for that stock is $20.00. ($1 estimated EPS x 20 P/E ratio = $20.00 fair value.)

If the analyst then raises his earnings estimate to $1.10 per share ($1.10 estimated EPS), then the fair value would now be $22.00. ($1.10 est. EPS x 20 P/E = $22.00 fair value.)

Institutional investors then act on these changes in earnings estimates, typically buying those companies with rising earnings estimates, and selling those with falling earnings estimates.

Moreover, stocks that receive upward earnings estimate revisions are more likely to receive even more upward revisions in the future. This is true because many analysts will revise their earnings estimates slowly and incrementally. That means, if an analyst raised his earnings estimates last month, he’s likely to do it again this month. And other analysts are likely to do the same.

Since stocks respond to earnings estimate revisions, it’s very profitable to buy stocks who earnings estimates are being raised. And by getting into stocks whose earnings estimates are being raised, you’re likely getting into companies whose future earnings estimates will be raised as well, potentially influencing stock prices even more.

That’s why stocks receiving upward earnings estimate revisions tend to outperform over the next one to three months.

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A Few Of My Favorite Things

The Zacks Rank has made the process of identifying stocks with upward earnings estimate revisions easy and very profitable.

But there are more than 4,800 stocks with earnings estimates. And while only the top 5% (about 240 stocks) with the best earnings estimate revisions can get a Zacks Rank #1, that’s still too many to trade at once. (Not to mention the 15% (about 720 stocks) that can get a Zacks Rank #2.)

So, the next step is to narrow that down to the best 5-10 stocks that you can buy.

In addition to the Zacks Rank, I also like using the Zacks Industry Rank. Since roughly half of a stock’s price movement can be attributed to the group that it’s in, it’s important to get into the best groups. And since stocks in the top 50% of Zacks Ranked Industries outperform the bottom 50% by a factor of more than 2 to 1, this is an ideal way to find them.

I also like a strong growth rate. But not crazy high growth rates, as stocks with the highest growth rates test nearly as poorly as those with the lowest growth rates. That’s because they are unsustainable.

For example, a company earning 1 cent a share that is now expected to earn 6 cents, has a 500% growth rate. But, if it receives a downward estimate revision to 5 cents, that’s a significant drop. Even though it still has a 400% growth rate, the estimates were just reduced by -16.7% and the price is likely to follow.

Instead, I have found that stocks with ‘just’ double-digit growth rates typically outperform stocks with triple-digit growth rates. And I have found that focusing on stocks with growth rates above the median for their industry, but less than 50%, is the best way to find solid outperformers with a lesser chance to disappoint.

I’m also a big fan of the Price to Sales ratio. In my studies, I have found that a P/S ratio of less than 1 has produced significantly superior results. Between 1 and 2 also do quite well. Solid returns can also be seen between 2-3, and even 3-4, but the returns taper off the higher you go. And those with a P/S ratio over 4, in aggregate, have typically shown to lose money. That doesn’t mean that all stocks with a P/S ratio of less than 1 will go up and those over 4 will go down, but you can greatly increase your odds of success by following these valuations.

These are just a few of my favorite things.

And it fits my trading style.

What Kind Of Trader Are You?

While there are many different ways to find winning stocks, identifying what kind of trader you are will help you get into the right stocks for you.

This is important because if you find yourself in a stock that’s not in alignment with who you are as a trader or investor, or the kinds of stocks you want to be in, you’re going to drop that stock or strategy (no matter how well it has proven to work), the moment it hits a rough patch.

There are many different styles of trade. Growth, Value, Momentum, and Income are the four most popular styles. Then you have technical analysis. Or those who focus on thematic investing. Or options. Or a combination of some or all of the above. And more.

The point is, there are certain items that have proven to work in each of these styles. And if they fit with how you want to trade, and the stocks you want to be in, all the better.

Interestingly, very few traders and investors fit into just one style. Many have parts of several styles within them.

In my own description of my favorite things, you can see I fall into that camp as well.

But I don’t limit myself to just my own ideas.

At Zacks I have access to professionals that focus on their preferred styles that make them successful stock pickers.

And so can you.

For example, in the Value Investor service, you’ll see several stocks with triple-digit open positions and numerous other double-digit gainers that you may never have considered on your own because you weren’t focused on classic value stocks.

But once those recommendations were brought to your attention, you’d likely see the merits of those picks that fit your style, and get in accordingly.

And you’d be glad you did.

Same for our Home Run Investor service that focuses on growth. Or our Income Investor service. Or our trading services like Insider Trader, or Large-Cap Trader, or Surprise Trader.

Or our industry specific services like Technology Innovators or Healthcare Innovators.

All in all, 19 different services that cover an array of styles and topics, designed to bring to you the best picks.

We all like seeing top 10 lists or top 20 lists of someone’s favorite books, or restaurants, or vacation spots, etc. Who doesn’t?

And that’s what these services are like. And they’re updated regularly. Whether you latch onto one service only, or enjoy looking at some or all the services, you’ll undoubtedly be introduced to stocks you may never have heard of before or considered investing in, and it can make all the difference.

Because let’s face it, most people aren’t seeing the kinds of returns they’d like to see in their portfolios because their universe of familiar stocks is small or limited to just what they know.

Think about it – how many times have you heard about a stock or read about a stock that skyrocketed in price, and you thought to yourself, ‘I would have been in that had I only known about it.'

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Thanks and good trading,

Kevin

Kevin Matras serves as EVP of Zacks.com and is responsible for all of its leading products for individual investors. He invites you to start our see-all Zacks Ultimate $1 experience and download the Ultimate Four Special Report today.

¹ The results listed above are not (or may not be) representative of the performance of all selections made by Zacks Investment Research's newsletter editors and may represent the partial close of a position.