Tapping stocks that come up with solid earnings is a common practice. But instead of picking them post earnings, investing in those that are like to beat market expectations may increase your gains manifolds.
Why Is Positive Earnings Surprise So Important?
Historically, stocks of companies with solid quarterly earnings (on a nominal basis) fall if they miss or just meet 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 question.
There is also the factor of seasonal fluctuation. 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 ambiguous while judging the company’s true health.
Meanwhile, Wall Street analysts study companies’ financials and initiatives to forecast earnings. They in fact club their insights and the company’s guidance to arrive at 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.
How to Find Those Gems?
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 surpass 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 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 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 around eight.
Here are five of the seven stocks that passed the screen:
Sleep Number Corporation SNBR: The company is a manufacturer of beds as well as foundations and bedding accessories. It has a Zacks Rank #1.
YETI Holdings Inc. YETI: The company designs, markets and distributes products for the outdoor and recreation market under the YETI brand primarily in the United States. It carries a Zacks Rank #2.
Adient PLC ADNT: This company is one of the world’s largest automotive seating supplier. It presently has a Zacks Rank #2.
Zoom Video Communications Inc. ZM: This Zacks Rank #1 company provides videotelephony and online chat services through a cloud-based peer-to-peer software platform and is used for telecommuting.
SailPoint Technologies Holdings Inc. SAIL: This company is a provider of enterprise identity governance solutions. It currently has a Zacks Rank #2.
You can get the rest of the stocks on this list by signing 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.
The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.
Click here to sign up for a free trial to the Research Wizard today.
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.
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
Adient PLC (ADNT) : Free Stock Analysis Report
Sleep Number Corporation (SNBR) : Free Stock Analysis Report
SailPoint Technologies Holdings, Inc. (SAIL) : Free Stock Analysis Report
YETI Holdings, Inc. (YETI) : Free Stock Analysis Report
Zoom Video Communications, Inc. (ZM) : Free Stock Analysis Report
To read this article on Zacks.com click here.
Zacks Investment Research