In the heart of the third-quarter earnings season, investors’ feverish search for earnings beat is understandable. Investors love an earnings beat because it usually always translates into stock price appreciation. In fact, a beat works better than earnings growth in this regard. We’ll tell you why.
What Makes Earnings Beat So Intriguing?
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 raise serious doubts.
Also, seasonal fluctuations are crucial in determining a company’s earnings growth. If a company’s Q1 is seasonally weak and its Q4 is strong, it is likely to report a sequential earnings decline in Q1. In such cases, growth rates are misleading when it comes to analyzing the true picture of a company.
On the other hand, Wall Street analysts rack their brains to study companies’ financials and initiatives to forecast earnings. They in fact club their insights and the company’s guidance to derive an earnings estimate.
Thus, beating this key number is almost equivalent to beating the company’s own expectation as well as the market perception. And if the margin of surprise is big, it typically drives the stock higher right after the release.
Now, since it is difficult to foretell if a company will beat or miss in the upcoming earnings season, investors can check its earnings surprise history. An impressive track record generally acts as a catalyst, sending the stock higher. It proves the company’s ability to surpass estimates. And investors generally believe that the company will have the same trick up its sleeve or, in other words, is smart enough to beat on earnings in its next release as well.
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 has narrowed down the universe from over 7,700 stocks to around five.
Here are the five stocks that passed the screen:
Activision Blizzard Inc. ATVI: The company is a pure-play online and console game publisher. It has a VGM Score of C. The stock belongs to a Zacks Industry Rank is in the top 19% and has a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
Callaway Golf Company ELY: The company manufactures and markets innovative golf clubs. The stock carries a Zacks Rank #1 and has a VGM Score of A. Its Zacks Industry Rank is in the top 25%.
Electronic Arts Inc. EA: This maker of entertainment software carries a Zacks Rank #2. Its Zacks Industry Rank is in the top 19%. It has a VGM score of B.
Rush Enterprises Inc. RUSHA: This operater of the largest network of Peterbilt heavy-duty truck dealerships in North America and John Deere construction equipment dealerships in Texas and Michigan sports a Zacks Rank #1. The stock has a VGM Score of A.
Zumiez Inc. ZUMZ: This is a leading specialty retailer of action sports related apparel, footwear, equipment and accessories. The stock has a Zacks Rank #1 and a VGM Score of B.
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.
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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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Rush Enterprises, Inc. (RUSHA) : Free Stock Analysis Report
Callaway Golf Company (ELY) : Free Stock Analysis Report
Zumiez Inc. (ZUMZ) : Free Stock Analysis Report
Activision Blizzard, Inc (ATVI) : Free Stock Analysis Report
Electronic Arts Inc. (EA) : Free Stock Analysis Report
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