There is no surprise that before an earnings season, every investor looks for stocks that can beat market expectation. This is because investors always try to position themselves ahead of time and look to tap stocks that are high-quality in nature.
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 earnings growth has been exhibiting a decelerating trend.
Also, seasonal fluctuations come into play sometimes. If a company’s Q1 is seasonally weak and Q4 is strong, then 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 much brainstorming and analysis of companies’ financials and initiatives, Wall Street analysts project earnings of companies. They in fact club their insights and a company’s guidance 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 Find Stocks that Can Beat?
Now, finding stocks that have the potential to beat on the bottom line may be investors’ dream but not an easy job. One way to do this is to look at the earnings surprise history of the company.
An impressive track in this regard generally acts as a catalyst in sending a stock higher. It indicates the company’s ability to surpass estimates. And investors generally believe that the company will apply the same secret sauce to execute yet another earning beat in its 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 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 equal to 1 or 2:Only companies with a Strong Buy or 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.
Just these few criteria narrows down the universe from over 7,700 stocks to around 16!
Here are five of the 16 stocks that passed the screen:
Callaway Golf Company (ELY): The Zacks Rank #1 (Strong Buy) company is renowned for developing innovative products for golfers. It belongs to a top-ranked Zacks industry (top 12%).
Herbalife LTD. (HLF):This Zacks Rank #1global network marketing company offers a range of science-based weight management products, nutritional supplements and personal care products intended to support weight loss and a healthy lifestyle. It hails from a top-ranked Zacks industry (top 15%).
IAC/InterActiveCorp (IAC): This is a leading media and Internet company. It has a Zacks Rank #1. It belongs to a top-ranked Zacks industry (top 38%).
Inogen Inc. (INGN): It is a medical technology company and carries a Zacks Rank #1. It belongs to a top-ranked Zacks industry (top 32%).
Salesforce.com Inc (CRM): This Zacks Rank #1 company is the market and technology leader in on-demand business services. It belongs to a top-ranked Zacks industry (top 38%).