There is no mystery to investors’ hunt for stocks with estimate beating potential ahead of an earnings season. This is because investors always try to place themselves ahead of time and look to play stocks that are rich in quality.
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 it has been decelerating.
Also, seasonal fluctuations can come into play. If a company’s Q1 is seasonally weak and Q4 is strong, it is likely to report a sequential earnings decline. In such cases, growth rates are misleading while judging the true health of a company.
On the other hand, after a whole lot of research and analysis on a company’s financials and initiatives, Wall Street analysts project its earnings. They also take a company’s guidance into consideration 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 Locate Potential Outperformers?
Now, finding stocks that have the potential to beat on the bottom line is a dream that investors chase but might not always come true. One way of fulfilling it is by looking at the earnings surprise history of a company.
An impressive track in this regard generally acts as a driver in sending a stock higher. It indicates the company’s ability to exceed estimates. And investors generally believe that the company will have the same trick up its sleeve to deliver yet another earning beat in its upcoming 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 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 push up 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 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 have narrowed down the universe from over 7,700 stocks to nine.
Here are five out of the nine stocks:
Columbia Sportswear Company (COLM): This is a global leader in design, sourcing, marketing and distribution of active outdoor apparel and footwear, with operations in North America, Europe and Asia. It belongs to a top-ranked Zacks sector (top 28%). The stock carries a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
Tactile Systems Technology Inc. (TCMD): It is a medical technology company that develops medical devices for the treatment of chronic diseases at home. It has a Zacks Rank #2. The stock belongs to a top-ranked Zacks industry (top 30%).
Wright Medical Group N.V. (WMGI): The Zacks Rank #1 company is a medical device company focused on providing extremity and biologic solutions. It hails from a top-ranked Zacks industry (top 30%).
Carbonite Inc. (CARB): It is a computer service company which provides online backup solutions for consumers and small and medium-sized businesses. It belongs to a top-ranked Zacks industry (top 13%) and has a Zacks Rank #2.
Palo Alto Networks Inc. (PANW): This Zacks Rank #2 company offers a network security platform that allows enterprises, service providers, and government entities to secure their networks. The company belongs to a top-ranked Zacks industry (top 7%).
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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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Palo Alto Networks, Inc. (PANW) : Free Stock Analysis Report
Carbonite, Inc. (CARB) : Free Stock Analysis Report
Tactile Systems Technology, Inc. (TCMD) : Free Stock Analysis Report
Wright Medical Group N.V. (WMGI) : Free Stock Analysis Report
Columbia Sportswear Company (COLM) : Free Stock Analysis Report
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