No prizes for guessing what lifts or dampens investors’ spirits after a company’s quarterly financial results are released. Of course it is earnings beat. 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 followingas 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 around six.
Here are five out of six stocks that passed the screen:
WellCare Health Plans Inc. : The company is a provider of managed care services exclusively targeting government-sponsored healthcare programs. Its VGM score is “A”. The stock belongs to a Zacks Industry Rank is in the top 17%. The stock has a Zacks Rank #2.
Best Buy Co. Inc. (BBY - Free Report) : The company is a leading retailer. The stock carries a Zacks Rank #2 and has a VGM score of “B”. Its Zacks Industry Rank is in the top 4%.
Owens Corning (OC - Free Report) : This world leader in building materials systems and composite solutions sports a Zacks Rank #1. Though the Zacks Industry Rank of the stock is in the bottom 41%, its Sector rank is in the top 31%. It has a VGM score of “B”.
Five9 Inc. (FIVN - Free Report) :This provider of cloud software for contact centers holds a Zacks Rank #2. The Zacks Industry Rank of the stock is in the top 36%.
XPO Logistics Inc. (XPO - Free Report) : It is a third-party logistics provider offering single-source solutions for service-sensitive shipments through its non-asset-based transportation network.The stock has a Zacks Rank #2 and VGM score of “A”.
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: https://www.zacks.com/performance.
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