Gone are the days when investors were content with just earnings growth. Now, higher earnings (irrespective of the magnitude) seem inadequate for solid moves in stock prices. It is the “beat” that matters the most.
Why Should You Prioritize Earnings Beat?
A positive earnings surprise or 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.
This is because investors always try to take positions ahead of time and look for stocks that are likely to come up with a stellar performance. Now, since Wall Street analysts project earnings of companies after much deliberation, their estimates act as investment leads.
After all, only earnings beat can give investors a clear picture of a company’s strength when an industry-wide earnings recession is felt. A 20% earnings rise (though apparently looks good) doesn’t tell you everything about the company’s performance. This might represent a decelerating earnings growth momentum over the years or quarters, raising questions over the company’s fundamentals.
Also, seasonal fluctuations come into play at times. 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.
How to Find the Hidden Gems?
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 record in this regard generally acts as a catalyst for the stock. 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 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 narrowed down the universe from over 7,700 stocks to around 14.
Here are five of the 14 stocks that passed the screen:
Arista Networks Inc. ANET: The company provides cloud networking solutions. The stock carries a Zacks Rank #1. Its Zacks Industry Rank is in the top 31%. You can see the complete list of today’s Zacks #1 Rank stocks here.
Zumiez ZUMZ: This specialty retailer of action sports carries a Zacks Rank #2. Its Zacks Industry Rank is in the top 42%. It has a VGM Score of A.
Fortinet Inc. FTNT: This provider of network security appliances carries a Zacks Rank #2. The stock has a VGM Score of B and its Zacks Industry Rank is in the top 14%.
NVIDIA Corp NVDA: This is a leading provider of graphics processors and media communications’ devices. The stock has a Zacks Rank #1 and its Zacks Industry Rank is in the top 2%.
Deckers Outdoor Corp DECK: The company is a designer and marketer of footwear, apparel and accessories. The stock carries a Zacks Rank #1. Its Zacks Industry Rank is in the top 19%.
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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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