It is not surprising for an investor to look for stocks that can beat market expectation during a reporting cycle. This is because investors always try to position themselves ahead of time and look to tap stocks that are high-quality in nature.
At the start of the ongoing reporting season, investors were slightly off due to the likelihood of an earnings recession. But the earnings picture does not look that bad. As of Apr 26, 2019, as much as 46% of the S&P 500 membership reported results. Of this, 79.1% beat EPS estimates and 58.7% beat revenue estimates. The proportion of positive EPS beats in Q1 at this stage is the second highest for this group of 230 S&P 500 members in the last five years.
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 is exhibiting a decelerating trend.
Also, seasonal fluctuations come into play sometimes. If a company’s Q1 is seasonally weak and Q4 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.
Meanwhile, 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 projection. 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 up.
As per the Earnings Trends issued on May 1, 2019, we have Q1 results from 75.7% of the S&P 500 market cap ( and 62.6% of the total companies). Total earnings are up 0.1% in the first quarter of 2019 from the same period last year on 3.8% higher revenues, with 78% beating EPS estimates and 61% beating revenue estimates.
Against this backdrop, investors must be interested in finding out lucrative bets from sectors that have solid earnings beat ratios so far this season. This shows the signs of strength in the sector. Below we highlight those to help investors decide on their future plays.
Aerospace – SPDR S&P Aerospace & Defense (NYSE:XAR) ETF (LON:XAR)
Around 80% of the companies of the sector (93.4% of the total market cap) reported so far have delivered an earnings beat ratio of 100%. Rising geopolitical tensions, higher defense spending from several countries and growing commercial demand have been the driving factors. The fund has a Zacks Rank #2 (Buy).
Medical– Health Care Select Sector SPDR Fund (XLV)
About 63% of the companies reported as of May 1, 2019 and 88.2% of them have come up with earnings beat. Also, there was an earnings growth of 8.9%. The fund has a Zacks Rank #1 (Strong Buy) (read: April ETF Asset Report: U.S. Equities & Treasuries Win).
Consumer – iShares U.S. Consumer Services ETF (IYC)
About 60% of the consumer staples companies, 42.4% of consumer discretionary companies and 38.5% of the retail companies have come up with earnings releases. And earnings beat ratios are 77.8%, 78.6% and 80%, respectively. The fund has a Zacks Rank #2.
A solid labor market, rising wages, subdued inflation and soaring stock market probably drove Americans' ability to spend on staples as well as discretionary stocks. The fund IYC is a mix of staples and discretionary stocks.
Industrials – Industrial Select Sector SPDR Fund (XLI)
About 75% of the companies have reported earnings so far and 83.3% have surpassed earnings estimates. U.S.-China trade optimism and a dovish Fed are other reasons to bet on this space. The fund has a Zacks Rank #1 (read: ETFs in Focus Post General Electric (NYSE:GE)'s Q1 Earnings Report).
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iShares U.S. Consumer Services ETF (IYC): ETF Research Reports
SPDR S&P Aerospace & Defense ETF (XAR): ETF Research Reports
Health Care Select Sector SPDR Fund (XLV): ETF Research Reports
Industrial Select Sector SPDR Fund (XLI): ETF Research Reports
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Zacks Investment Research