The Q3 earnings season has been pretty decent so far. Notably, 24.8% of the S&P 500 companies have reported, out of which about 82.3% of companies beat EPS estimates, per the Earnings Trends issued on Oct 23. As a matter of fact, earnings beat or a positive earnings surprise seems to be a greater driver of stock movement.
Inside Earnings Surprise
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 Find Out Likely 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 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 Zacks Rank #1 (Strong Buy) or 2 (Buy) 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 (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 of more than 7,700 stocks to around nine.
Here are five out of the nine stocks that passed the screen:
Columbia Sportswear Company (COLM - Free Report) : This Zacks Rank #1 company engages in the sourcing, marketing and distribution of outdoor and active lifestyle apparel, footwear, accessories and equipment in the United States and internationally.
Boot Barn Holdings Inc. (BOOT - Free Report) : This company operates as a lifestyle retail chain devoted to western and work-related footwear, apparel and accessories. The stock belongs to a top-ranked Zacks industry (top 11%). The stock has a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
Vertex Pharmaceuticals Incorporated (VRTX - Free Report) : This company is focused on the discovery, development and commercialization of small molecule drugs targeting serious diseases. The company’s main area of focus is cystic fibrosis. It sports a Zacks Rank #1. The stock hails from a top-ranked Zacks industry (top 29%).
Upland Software Inc. (UPLD - Free Report) : This provider of cloud-based Enterprise Work Management software carries a Zacks Rank #2. The stock belongs to a top-ranked Zacks industry (top 24%).
Spotify Technology SA (SPOT - Free Report) : This Zacks Rank #2 company provides music streaming services. The stock is from a top-ranked Zacks industry (top 37%).
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.