Investors are always hunting for estimate-beating stocks before an earnings release. It is because investors always try to place themselves ahead of time and look to play stocks that are rich in quality and have high chances of beating earnings estimates.
Why Is a Positive Earnings Surprise So Important?
Historically, stocks of companies with solid quarterly earnings (on a nominal basis) tank if they miss or merely meet market expectations. After all, a 20% earnings rise (though apparently looks good) doesn’t tell you if it has been decelerating.
Also, seasonal fluctuations can come into play. If a company’s Q1 is seasonally weak and Q4 is 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 a whole lot of research and analysis on a company’s financials and initiatives, Wall Street analysts project its earnings. They also take a company’s guidance into consideration when deriving an earnings estimate.
Thus, outperforming that estimate is almost equivalent to beating the company’s own expectation as well as the market perception. And if the margin of earnings surprise is big, it typically drives the stock higher right after the release. Thus, more than anything else, an earnings surprise can push a stock higher.
How to Locate Potential Outperformers?
Now, finding stocks that have the potential to beat on the bottom line is a dream that investors chase but might not always come true. One way of fulfilling it is by looking at the earnings surprise history of a company.
An impressive track in this regard generally acts as a driver in sending a stock higher. It indicates the company’s ability to exceed estimates. And investors generally believe that the company will have the same trick up its sleeve to deliver yet another earning beat in its upcoming 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 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 14.
Here are five out of 14 stocks that passed the screen:
Amazon.com Inc. (AMZN - Free Report) : Amazon.com engages in the retail sale of consumer products and subscriptions in North America and internationally. The stock belongs to a top-ranked Zacks industry (top 21%) and sports a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
Molina Healthcare Inc (MOH - Free Report) : The Zacks Rank #1 company is a multi-state healthcare organization. The stock comes from the top-ranked Zacks industry (top 13%).
John Bean Technologies Corporation (JBT - Free Report) : The Zacks Rank #1 company is a leading global solutions provider to the food processing and air transportation industries. The stock belongs to a top-ranked Zacks industry (top 9%).
Square Inc. (SQ - Free Report) : This provider of financial services and marketing services carries a Zacks Rank #2. The stock hails from a top-ranked Zacks Rank (top 26%).
Martin Marietta Materials Inc. (MLM - Free Report) : The company is engaged principally in the building materials business, including aggregates, cement, ready mixed concrete and asphalt, and paving product lines. The stock has a Zacks Rank #1 and belongs to a top-ranked Zacks industry (top 17%).
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.