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3 Keys to Identify the Best Profit Opportunities

Stocks have come roaring out of the gate in 2023 in stark contrast to last year’s bear market. Optimism surrounding a slowdown in the pace of interest rate hikes, along with avoiding a potential recession, has sent markets higher to kick off the new year. Still, many individual stocks remain in downtrends, well below their peaks from two years ago.

Given that uncertainty remains as inflation continues to linger and corporate earnings are set to fall, it pays to be very selective. How do we go about narrowing down our list to stocks with the best profit potential? I’ll lay out a three-step process that can guide us in this endeavor.

Industry Group Association

We can start by detecting leading industry groups. The Zacks Industry Group Rank makes this process easy for investors, classifying industries based on the earnings estimate revisions of the underlying stocks within each industry. If the stocks within a given group are experiencing positive earnings revisions, that industry will receive a higher ranking. Let’s take a look at an example.

The Zacks Manufacturing – Farm Equipment industry is ranked in the top 16% out of approximately 250 industries. Because it is ranked in the top half of all Zacks Ranked Industries, we expect this group to outperform over the next 3 to 6 months. Digging a bit deeper, this industry has held up relatively well over the past year (+14.07%).

Quantitative research studies suggest about half of a stock’s future price appreciation is due to its industry grouping. By targeting stocks contained within leading industry groups, we can dramatically improve our odds of success. Also note the favorable characteristics for this group below:

Zacks Investment Research
Zacks Investment Research


Image Source: Zacks Investment Research

Rising Earnings Estimates

Positive earnings estimate revisions are at the heart of the Zacks Rank. Our research shows that rising earnings estimates are the most powerful force impacting stock prices. Only the top 20% of all stocks that are experiencing the most substantial revisions are ranked as either a Zacks Rank #1 (Strong Buy) or Zacks Rank #2 (Buy). Let’s build on our example.

Within the Zacks Manufacturing – Farm Equipment industry, Deere & Co. DE is a Zacks Rank #2 (Buy) stock. DE is an American manufacturer of construction, agricultural, engine, forestry, and lawn care equipment. Deere is well-known for its tractors, mowing equipment, excavators, milling machines, and sports turf care applications.

The machinery manufacturer has witnessed a steady batch of positive earnings estimate revisions as of late. For the current fiscal year, eleven different analysts have increased their EPS estimates by 5.21% in the past 60 days. The 2023 Zacks Consensus Estimate is now $27.85 per share, which translates to a 19.63% growth rate relative to last year. This is the type of trend we want to look for when narrowing down our list of stocks to include in our portfolio.

Zacks Investment Research
Zacks Investment Research


Image Source: Zacks Investment Research

Relative Strength

One of the most useful measures to help investors identify leading stocks and funds in any market environment is relative strength. This technical analysis tool assists us in gauging how an investment has performed relative to the market or another relevant benchmark. For example, we could use relative strength to detect stocks that have outperformed the S&P 500.

Critics of relative strength as an indicator typically associate it with momentum investing, but I don’t view it that way. The market ultimately decides which stocks are best positioned for the present and future periods, and this tool helps us recognize those stocks.

We can see below that DE has displayed relative outperformance versus the S&P 500 over the past six months:

StockCharts
StockCharts


Image Source: StockCharts

Simply put, in order to outperform the market, we need to be invested in stocks that are outperforming.

What the Zacks Model Unveils

The Zacks Earnings ESP (Expected Surprise Prediction) identifies companies that have recently witnessed positive earnings estimate revision activity. The idea is that this more recent information can serve as a better predictor of the future, giving investors a leg up during earnings season. When combining a Zacks Rank #3 or better with a positive Earnings ESP, stocks produced a positive surprise 70% of the time according to our 10-year backtest.

With an Earnings ESP of +3.08% and a Zacks Rank #2 (Buy) rating, another earnings beat may be in the cards for DE investors when the company reports fiscal Q1 results on February 17th.

By focusing on stocks that are within leading industry groups, experiencing positive earnings estimate revisions, and that are showing relative strength, we can narrow down our list of stocks to those with the best profit potential.

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report

Deere & Company (DE) : Free Stock Analysis Report

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Zacks Investment Research

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