The last few hours before the release of a company’s quarterly financial results are crucial to investors. Their main concern is whether the companies that they are invested in can beat the earnings estimate. This is because an earnings beat generally translates into price appreciation. In fact, it works better than earnings growth in this regard. We’ll tell you why.
Inside the Importance of Earnings Beat
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 it is a decelerating growth momentum. If that is the case, the company’s fundamentals are in serious trouble.
Also, seasonal fluctuations are a vital factor in determining a company’s earnings growth. If a company’s Q1 is seasonally weak and its Q4 is strong, then it is likely to report a sequential decline in earnings in Q1. In such cases, growth rates are fallacious when it comes to analyzing the true picture of a company.
On the other hand, Wall Street analysts rack their brains in order 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 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.
Earnings ESP greater than zero: 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.
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 12.
Here are five out of the 12 stocks:
WellCare Health Plans Inc. (WCG - Snapshot Report) : This is a provider of managed care services targeted solely at government-sponsored healthcare programs with the Zacks Industry Rank in the top 13%. The stock has a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
The Chemours Company (CC - Snapshot Report) : The Zacks Rank #1 company is into chemical business. The Zacks Industry Rank of the stock is in the top 36%.
Teck Resources Limited (TCK - Snapshot Report) : The company is into mining and mineral development. The Zacks Industry Rank of the stock is in the top 6%. Teck Resourcescarries a Zacks Rank #1.
Paylocity Holding Corporation (PCTY - Snapshot Report) : This is a provider of cloud-based payroll and human capital management software solutions. The Zacks Industry Rank of the stock is in the top 30%. The stock has a Zacks Rank #1.
Best Buy Co. Inc. (BBY - Analyst Report) : The company sells personal computers, consumer electronics, major appliances and related accessories mainly through its retail stores. The Zacks Industry Rank of the stock is in the top 13%, at the time of writing. The stock has a Zacks Rank #2.
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.
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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: http://www.zacks.com/performance.
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