It is not surprising that before an earnings season, every investor looks for stocks that can beat market expectation. This is because investors always try to position themselves ahead of time and tap stocks that are of high-quality in nature.
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 earnings growth has been exhibiting a decelerating trend.
Also, seasonal fluctuations come into play sometimes. If a company’s Q1 is seasonally weak and Q4 strong, then 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 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 Stocks that Can Beat?
Now, finding stocks that have the potential to beat on the bottom line may be investors’ dream but 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 in sending a stock higher. It indicates the company’s ability to surpass estimates. And investors generally believe that the company will apply the same secret sauce to execute yet another earning beat in its next 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 five.
Here are all five stocks:
Care.com Inc. ): Care.com, Inc. provides an online marketplace for finding and managing family care primarily in the United States and internationally. It belongs to a favorable Zacks industry (placed at the top 12% of 250+ industries). The stock carries 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, and has offices in CA and FL. It has a Zacks Rank #2. It belongs to a favorable Zacks industry (top 32%).
Fortinet, Inc. (FTNT - Free Report) : The Zacks Rank #1 company is a provider of network security appliances and Unified Threat Management network security solutions to enterprises, service providers and government entities worldwide. It belongs to a favorable Zacks industry (top 3%).
Navient Corporation (NAVI - Free Report) : Navient is one of the four large servicers to the U.S. Department of Education (ED) under its Direct Student Loan Program (DSLP). It comes from a favorable Zacks industry (top 23%) and sports a Zacks Rank #1.
SPS Commerce Inc. (SPSC - Free Report) : This Zacks Rank #1 provider of on-demand supply chain management solutions, is providing integration, collaboration, connectivity, visibility and data analytics to its customers worldwide. It hails from a favorable Zacks sector (top 25%).
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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.