Forget Growth; Focus On Earnings Beat With These 4 Stocks

Equity investors hold their breath before an earnings release. This is because earnings supposedly determine the company’s financial health. No wonder, solid earnings growth speaks about business well-being, but there is another metric which works better in determining the future direction of stock price, i.e. positive earnings surprise or earnings beat. Let’s tell you why it is so important.

What is Earnings Beat?

Investors always try to position themselves ahead of time and look for stocks that are likely to come up with a stellar performance. After much brainstorming, Wall Street analysts project earnings of companies. These estimates act as investment leads.

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.

Why Earnings Beat is Superior to Earnings Growth?

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 the 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, analysts put together their insights and a company’s guidance when giving an earnings estimate. Thus, outperforming that estimate is almost equivalent to beating the company’s own expectation as well as market perception. Of course, this gives you a clear picture of the company’s bottom line. And if the margin of earnings 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 predict if a company will beat or miss in the upcoming earnings season, investors can check the earnings surprise history. 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 have the same trick up its sleeve or in other words is smart enough to beat on earnings 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: Only companies with a Strong 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 six!

Here are four of the six stocks that passed the screen:

Tallgrass Energy GP LP (NYSE:TEGP) : The partnership is a contributor of crude transportation services in Wyoming and adjoining areas. It has a VGM score of “A” and expected EPS growth rate of 90.6% for this year.

PharMerica Corporation (NYSE:PMC) : This is an institutional pharmacy services company that sports a VGM score of “A”. The company’s estimated earnings growth rate for this year is 31.9%.

Dave & Buster's Entertainment Inc. (NASDAQ:PLAY) : The company – with a VGM score of “A” – owns and operates dining and entertainment venues. Its estimated earnings growth rate for this year is 29.21%.

Bristol-Myers Squibb Company (NYSE:BMY) : The company – with a VGM score of “F” – makes, markets, and sells biopharmaceutical products globally. Its estimated earnings growth rate for this year is 29.5%.

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.

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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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