The Q4 earnings season is approaching its tail end as 72.4% of the S&P 500 companies have already reported results. Meanwhile, investors’ hunt for potential outperformers is still on.
While evaluating earnings performance, there are various factors investors normally take a look at. But among all these, earnings beat seems to be a more powerful driver of stock movement than factors like earnings growth or acceleration. A positive earnings surprise or earnings beat is typically the case when actual or reported earnings come in above the consensus estimates.
What Makes Earnings Beat Superior to Earnings Growth
Investors always try to prepare themselves ahead of time and search for stocks poised to come up with a stellar performance. After much thinking, Wall Street analysts project earnings of companies. These estimates act as investment leads. Historically, if a company’s earnings beat market expectations, its stock surges post release.
This is becausea 20% earnings rise (though apparently looks good) doesn’t tell you everything about the company’s performance. This might represent decelerating earnings growth momentum over the years or quarters, raising questions over the company’s fundamentals.
Also, seasonal fluctuations come into play sometimes. If a company’s Q1 is seasonally weak and Q4 is strong, then 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, analysts put together their insights and a company’s guidance when giving an earnings estimate. Thus, outperforming that estimate is almost equivalent to beating the company’s own expectation as well as market perception.
How to Find Stocks that Can Beat?
Since it is difficult to predict if a company will beat or miss in the upcoming earnings season, investors can check the earnings surprise history. An impressive track in this regard generally acts as a catalyst in sending a stock higher. It indicates 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.
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 Strong Buy or 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 (Strong Buy), 2 (Buy) 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 have narrowed down the universe from over 7,700 stocks to around seven.
Here are five out of the seven stocks:
Wolverine World Wide Inc. (WWW - Free Report) : This Zacks Rank #2 stock is one of the world's leading marketers of branded casual, active lifestyle, outdoor sport, hildren's and uniform footwear and apparel. The Zacks Industry Rank of the stock is in the top 17%.
MarineMax Inc. (HZO - Free Report) : The stock is the nation's largest recreational boat and yacht retailer. The Zacks Industry Rank of the stock is in the top 5%. The stock sports a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
T-Mobile US Inc. (TMUS - Free Report) : The Zacks Rank #2 stock is a national provider of mobile communications services. The VGM (Value, Growth, Momentum) score of the stock is A.
SolarEdge Technologies Inc. (SEDG - Free Report) : The Zacks Rank #1 stock is a provider of inverter solution. The Zacks Industry Rank of the stock is in the top 49%.
Sunrun Inc. (RUN - Free Report) : This developer and seller of residential solar energy systems sports a Zacks Rank #1. The Zacks Industry Rank of the stock is in the top 49%.
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.
The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.
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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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