The third-quarter earnings season is on its last leg, but investors’ fervent search for earnings beat may not have ended. They will still look for an earnings beat in the rest of the to-be-reported quarter. Investors love earnings beat because it usually always translates into stock price appreciation. In fact, a beat works better than earnings growth in this regard. We’ll tell you why.
What Makes Earnings Beat So Intriguing?
Historically, stocks of companies with solid quarterly earnings (on a nominal basis) fall if they miss or just come in line with market expectations. After all, a 20% earnings rise (though it looks good apparently) doesn’t tell you if earnings growth has been exhibiting a decelerating trend. If that is the case, the company’s fundamentals raise serious doubts.
Also, seasonal fluctuations are crucial in determining a company’s earnings growth. If a company’s Q1 is seasonally weak and its Q4 is strong, it is likely to report a sequential earnings decline in Q1. In such cases, growth rates are misleading when it comes to analyzing the true picture of a company.
On the other hand, Wall Street analysts rack their brains to study companies’ financials and initiatives to forecast earnings. They in fact club their insights and the company’s guidance to derive an earnings estimate.
Thus, beating this key number is almost equivalent to beating the company’s own expectation as well as the market perception. And if the margin of surprise is big, it typically drives the stock higher right after the release.
Now, since it is difficult to foretell if a company will beat or miss in the upcoming earnings season, investors can check its earnings surprise history. An impressive track record generally acts as a catalyst, sending the stock higher. It proves 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 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 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 of #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 has narrowed down the universe from over 7,700 stocks to around five.
Here are the five stocks that passed the screen:
Care.com Inc. : The company provides an online marketplace for finding and managing family care primarily in the United States and internationally. The stock belongs to a favorable Zacks industry (placed at the top 11% of 250+ industries) and has a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
Tenet Healthcare Corporation (THC - Free Report) ): The company is an investor-owned health care services company, which owns and operates general hospitals and related health care facilities for urban and rural communities in numerous states. The stock carries a Zacks Rank #2 and belongs to a favorable Zacks industry (top 11%).
Fortinet Inc. (FTNT - Free Report) ): This provider of network security appliances and Unified Threat Management network security solutions to enterprises, service providers and government entities worldwide carries a Zacks Rank #1. The stock hails from a favorable Zacks industry (top 4%).
Navient Corporation (NAVI - Free Report) ): Navient Corporation operates as a loan management, servicing and asset recovery company. It sports a Zacks Rank #1 and comes from favorable Zacks industry (top 25%).
SPS Commerce Inc. (SPSC - Free Report) : The provider of on-demand supply chain management solutions has a Zacks Rank #1. It hails from a favorable Zacks sector (top 19%).
You can sign 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.