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.
Meanwhile, 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 15.
Here are five of the 15 stocks:
Abercrombie & Fitch Company (ANF - Free Report) : This company has launched an integrated campaign for its Abercrombie & Fitch brand, marking the start of the holiday season. The stock comes from a top-ranked Zacks industry (top 27%). It carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
Pacira Pharmaceuticals Inc. (PCRX - Free Report) : It is a specialty pharmaceutical company. The stock belongs to a top-ranked Zacks industry (top 33%). The stock carries a Zacks Rank #2.
Penumbra Inc. (PEN - Free Report) : It is an interventional therapy company. The stock has a Zacks Rank #1 and hails from a top-ranked Zacks industry (top 26%).
Sprint Corporation (S - Free Report) : It offers communications services. It comes from a top-ranked Zacks sector (top 17%). It has a Zacks Rank #2.
Salesforce.com Inc. (CRM - Free Report) : This Zacks Rank #2 company is the market and technology leader of on-demand business services. The stock comes from a top-ranked Zacks sector (top 32%). 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.
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: http://www.zacks.com/performance.