Fourth-quarter 2019 earnings season has just kicked off with the 31 S&P 500 members reporting results, per Earnings Trends issued on Jan 15, 2020. Total earnings (or aggregate net income) are down 5.7% year over year on 3.5% higher revenues, with 77.4% surpassing EPS estimates and 74.2% beating on revenues.
While earnings weakness appears to be worrisome so far, impressive beat ratios are giving investors every reason to bet big on an equity market rally. This is because higher earnings (irrespective of the magnitude) are no more that important for solid moves in stock prices. It is the “beat” that matters the most.
Why Should You Prioritize Earnings Beat?
A positive earnings surprise or earnings beat is typically the case when actual or reported earnings come in above the consensus estimate. Historically, if a company’s earnings manage to beat market expectations, its stock surges post release.
This is because investors always try to take positions ahead of time and look for stocks that are likely to come up with a stellar performance. Now, since Wall Street analysts project earnings of companies after much deliberation, their estimates act as investment leads.
After all, only earnings beat can give investors a clear picture of a company’s strength when an industry-wide earnings recession is felt. A 20% earnings rise (though apparently looks good) doesn’t tell you everything about the company’s performance. This might represent a decelerating earnings growth momentum over the years or quarters, raising questions over the company’s fundamentals.
Also, seasonal fluctuations come into play at times. If a company’s Q1 is seasonally weak and Q4 is 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.
How to Find the Hidden Gems?
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 record in this regard generally acts as a catalyst for the stock. 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 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 narrowed down the universe from over 7,700 stocks to just three.
Here are all three stocks that passed the screen:
Zumiez Inc. (ZUMZ - Free Report) : The company is a specialty retailer for a range of apparel, footwear and accessories. Its stores also feature a range of hardgoods for youngsters, which include items like snowboards, skateboards, bindings and other equipment. The stock carries a Zacks Rank #1. The stock belongs to a favorable Zacks industry (placed at the top 36% of 250+ industries). You can see the complete list of today’s Zacks #1 Rank stocks here.
Neurocrine Biosciences Inc. (NBIX - Free Report) : This neuroscience-based company carries a Zacks Rank #2. The stock belongs to a favorable Zacks industry (top 41%). It has a VGM Score of A.
Covanta Holding Corporation (CVA - Free Report) : The company along with its subsidiaries is predominantly engaged in the business of waste and energy services, providing waste and energy solutions to its customers by processing the waste and generating energy out of it, which is named as Energy-from-Waste (EfW). The stock has a Zacks Rank #2.
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.
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.