Every investor looks for stocks that can beat market expectation ahead of an earnings season. This is because investors always try to prepare themselves before the release and intend to tap stocks that are of high quality. Now, in the thick of the fourth-quarter earnings season, investors need to understand why a beat is more important than earnings growth.
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.
Meanwhile, 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 raise 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, 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 5.
Here are all five stocks:
Zumiez Inc. (It is a specialty retailer for a range of apparel, footwear and accessories. The stock belongs to a favorable Zacks industry (placed at the top 41% of 250+ industries). The stock carries a Zacks Rank #1. You can see ZUMZ Quick Quote ZUMZ - Free Report) : . the complete list of today’s Zacks #1 Rank stocks here Neurocrine Biosciences Inc. : Neurocrine Biosciences is a neuroscience-based company focused on the discovery and development of novel therapeutics for neuropsychiatric, neuroinflammatory and neurodegenerative diseases and disorders. It has a Zacks Rank #2. The stock comes from a favorable Zacks industry (top 44%). NBIX HealthEquity Inc. : The Zacks Rank #2 company provides integrated solutions for health-care account management, health reimbursement arrangement and flexible spending accounts for health plans, insurance companies and third-party administrators in the United States.The stock comes from a favorable Zacks industry (top 29%). HQY Covanta Holding Corporation : The company is engaged in the business of waste and energy services, providing waste and energy solution to its customers Energy-from-Waste by processing waste and generating energy out of it. It hails from a top-ranked Zacks industry (top 22%) and sports a Zacks Rank #1. CVA SailPoint Technologies Holdings Inc. : This Zacks Rank #2 company is a provider of enterprise identity governance solutions. The company belongs to a top-ranked Zacks industry (top 42%). SAIL
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Disclosure: Performance information for Zacks’ portfolios and strategies are available at: . http://www.zacks.com/performance