Now that we are in the middle of the fourth-quarter earnings season, all investors’ eyes would be rested on the companies that beat on earnings. This is because more than the comparison with previous results, it is the positive earnings surprise that drives the market post an earnings release.
Why Is Earnings Surprise So Important?
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 are in serious question.
There is also the factor of seasonal fluctuation. If a company’s Q1 is seasonally weak and Q4 is strong, then it is likely to report a sequential earnings decline. In such a case, growth rates are ambiguous while judging the company’s true health.
On the other hand, Wall Street analysts study companies’ financials and initiatives to forecast earnings. They in fact club their insights and the company’s guidance to derive an earnings estimate. So, outperforming that estimate is almost equivalent to beating the company’s own expectation as well as market perception. And if the company manages to surpass earnings by a wide margin, it typically drives the stock higher right after the release.
Now, since it is hard to predict if a company will beat or miss in the upcoming earnings season, investors can check its earnings surprise history. A notable track record generally acts as a tailwind. It revs up chances of beating estimates in the next release too as investors expect the company to use the same old trick to come ahead of expectations, or is smart enough to pull off a beat in the next release.
The Winning Strategy
In order to shortlist stocks that are likely to come up with an earnings surprise, we chose the followingas our primary screening parameters.
Last EPS Surprise greater than or equal to 10%: Stocks that delivered a positive surprise in the last quarter are likely 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 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 stock has adequate liquidity.
With a handful of criteria, we narrowed down to only three stocks from the universe of more than 7,700.
Here are all three stocks:
Pacira Pharmaceuticals Inc. PCRX: This Zacks Rank #1company is a specialty pharmaceutical company focused on development, commercialization and manufacturing of proprietary pharmaceutical products, primarily for use in hospitals and ambulatory surgery centers. It belongs to a favorable Zacks industry (placed at the top 33% of 250+ industries). You can see the complete list of today’s Zacks #1 Rank stocks here.
Mitek Systems Inc. MITK: This Zacks #1 Ranked company is primarily engaged in the development and sale of software products with particular focus on intelligent character recognition and forms processing technology, products and services for the document imaging markets. It comes from a favorable Zacks industry (top 1%).
Fortinet Inc. FTNT: The Zacks Rank #2 company is a provider of network security appliances and Unified Threat Management (UTM) network security solutions to enterprises, service providers and government entities worldwide.It hails from a favorable Zacks industry (top 23%).
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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.
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Pacira Pharmaceuticals, Inc. (PCRX) : Free Stock Analysis Report
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