What drives shares or pulls them down after a company comes up with quarterly earnings? It’s not exactly how well a company performs in the recently concluded quarter or exhibits strong growth; it is an earnings beat or a miss which drives the market post release.
Investors always intend to take position ahead of time and fish for stocks that are likely to come up with an astounding performance. After much deliberation, Wall Street analysts forecast earnings of companies. These estimates act as investment leads.
The Importance of an Earnings Beat
A positive earnings surprise or an earnings beat is typically the case when actual or reported earnings come in above the consensus estimate. Historically, if a company’s earnings manage to beat market expectations, its stock surges post release.
After all, a 20% earnings rise (though it looks good apparently) doesn’t tell you if it is a decelerating growth momentum. If that is the case, the company’s fundamentals are in serious question.
Also, seasonal fluctuations are a vital factor in determining a company’s earnings growth. If a company’s Q1 is seasonally weak and its Q4 is strong, then it is likely to report a sequential decline in earnings in Q1. In such cases, the growth rates are fallacious when it comes to analyzing the true picture of a company.
On the other hand, Wall Street analysts 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.
How to Find Stocks that Can Beat?
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 tailwind, sending the stock higher. It indicates that the company might surpass estimates even 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 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 slightly 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 (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 stock has adequate liquidity.
A handful of criteria narrowed down the universe from over 7,700 stocks to 12.
Here are five out of the 12 stocks:
Diamondback Energy Inc. (FANG - Free Report) : This Zacks Rank #2 company is engaged in the exploration and development of unconventional, onshore oil and natural gas reserves in the Permian Basin in West Texas. The Zacks Industry Rank of the stock is in the top 23%.
Burlington Stores Inc. (BURL - Free Report) : It is an off-price apparel and home product retailer, with a Zacks Rank #1. The Zacks Industry Rank of the stock is in the top 15%. You can see the complete list of today’s Zacks #1 Rank stocks here.
Morgan Stanley (MS - Free Report) : It is a global financial services firm, with a Zacks Rank #1. The Zacks Industry Rank of the stock is in the top 14%.
Hannon Armstrong Sustainable Infrastructure Capital Inc. (HASI - Free Report) : This Zacks Rank #2 company is a real estate investment trust. The Zacks Industry Rank of the stock is in the top 21%.
Veeva Systems Inc. (VEEV - Free Report) : This Zacks Rank #2 company is a provider of cloud-based software solutions for the life sciences industry. The Zacks Industry Rank of the stock is in the top 26%.
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