Investors specifically look for stocks that have the ability to beat market expectations before an earnings season. This is because investors always try to place themselves ahead of time and look to bet on stocks that are high-quality in nature.
Why Is a Positive Earnings Surprise So Important?
Historically, stocks of companies with solid quarterly earnings (on a nominal basis) fall if they miss or merely meet market expectations. After all, a 20% earnings rise (though apparently looks good) doesn’t tell you if earnings growth has been exhibiting a decelerating trend.
Also, seasonal fluctuations come into play at times. If a company’s Q1 is seasonally weak and Q4 strong, 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, after much brainstorming and analysis of companies’ financials and initiatives, Wall Street analysts project earnings of companies. They in fact club their insights and a company’s guidance when arriving at an earnings estimate.
Thus, outperforming that estimate is almost equivalent to beating the company’s own as well as market’s expectations. And if the margin of earnings surprise is big, it typically drives the stock right after the release. Thus, more than anything else, an earnings surprise can push a stock higher.
How to Find Stocks That Can Beat?
Now, finding stocks that have the potential to beat on the bottom line is not an easy job. One way to do this is to look at the earnings surprise history of the company.
An impressive track in this regard generally acts as a catalyst, sending the stock higher. It indicates the company’s ability to surpass estimates. And investors usually believe that the company will apply the same secret formula to beat earning 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 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 few other criteria have narrowed down the universe from over 7,700 stocks to five.
Here are five out of the eight stocks:
Illumina Inc. (ILMN - Free Report) : This company serves the healthcare industry by unlocking the power of the genome. The stock comes from a top-ranked Zacks industry (top 42%). The stock carries a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
Weight Watchers International Inc (WTW - Free Report) : The company is the largest provider of weight control programs in the world. The stock belongs to a top-ranked Zacks industry (top 27%). The stock carries a Zacks Rank #1.
Inogen Inc. (INGN - Free Report) : The Zacks Rank #2 company is a medical technology company. The stock hails from a top-ranked Zacks industry (top 38%).
Caterpillar Inc. (CAT - Free Report) : This is a manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives. It comes from a top-ranked Zacks sector (top 13%). It has a Zacks Rank #1.
QUALCOMM Inc. (QCOM - Free Report) : This Zacks Rank #2 company is a world leader in 3G, 4G and next-generation wireless technologies. The stock comes from a top-ranked Zacks sector (top 22%). It 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.