Screen of the Week 03/15/2011: Surprise, Surprise
Screen of the Week 03/15/2011: Surprise, Surprise
Having just wrapped up earnings season a few weeks ago, one thing that strikes me is the amount of extreme reactions to the earnings announcements we've seen.
Seems like either a surprise up or surprise down was met with an immediate double-digit price reaction often in gap fashion.
Why the market has reacted so aggressively this go-around is an interesting topic.
But today, I'm more concerned with why, as an investor, you should care about surprises.
First off, an earnings surprise is simply when the company announces earnings above or below the consensus estimate going into the report.
If the company reports earnings above expectations, that's a positive surprise.
If they report earnings below expectations, that's a negative surprise.
The price reaction to such a surprise, by and large, is obvious up for an upward surprise and down for a downward surprise.
But let's review why it's so important and what it really means.
In short, an earnings surprise is a signal of what a company's future earnings could/are going to look like.
An upside surprise could mean that the company will see better earnings than first expected.
And a downside surprise would likely be interpreted that the company will see earnings lower than first expected.
The magnitude of the surprise will of course determine the size of the reaction that the market takes.
The idea, though, is that it's not just the extra dollars and cents that the company makes during the period, but what it implies for future earnings periods as well.
An extra 10 cent surprise in one quarter is great. But 10 cents times 4 quarters, that's an extra 40 cents.
Or let's look at it in percentages an extra 10% in one quarter is exciting. But now let's increase full year earnings by 10% or maybe even more. That's even more exciting.
The often extreme market reactions are about re-pricing the company's earnings prospects as fast as possible.
But not all surprises are created equal.
Top Line Growth or Cost Cutting?
A company can post better-than-expected earnings several ways the most popular are thru top line growth (sales) or cost savings.
Top line growth usually produces the biggest price reaction over cost cutting. An increase in sales is generally thought of as more sustainable than simple cost cutting strategies, because once you've cut costs, where's the future growth going to come from? You can only cut costs so much. You need sales to drive long term growth.
Seeing an increase in revenue derived from sales of core products is where real growth will come from and be considered higher quality.
What's the Future Hold?
Another important key is what the company sees as its future.
A positive surprise coupled with downward guidance will usually produce a negative reaction.
Why?
Because if the company surprises but then downgrades their future earnings potential, they effectively removed a good portion of the hope generated from the surprise. Stocks will often trade lower as the future outlook will likely be weaker than expected.
Remember, the market is forward looking.
Lastly, some surprises aren't really surprises at all. Some 'surprises' are anticipated by the market, either because a company has a history of continuously beating their estimates or the stock has already priced in a 'surprise' by running up or going down prior to the announcement. Therefore, the 'surprise' in that direction really wasn't a surprise at all. That's where you'll sometimes see an opposite reaction to an earnings surprise a buy the rumor sell the fact type event.
So while predicting which companies will surprise or not (and what the surprise is comprised of) is a difficult game the benefit of an earnings surprise will typically last for one to three months after a surprise is reported.
Coupled with the fact that companies that surprise have a tendency to surprise again in the future, this makes buying after an earnings surprise a profitable trading strategy.
Screen
The screen I'm running today starts off with:
* Last EPS Surprise greater than or equal to 10%
(Once again, stocks posting positive surprises have a tendency of surprising again.)
* Last Sales Surprise greater than or equal to 10%
(A positive sales surprise shows top line strength.)
* Average Broker Rating less than or equal to 2
(Varying degrees of average Strong Buys and Buys.)
* Price greater than or equal to $5
* Volume greater than or equal to 100,000
Just these few criteria narrows down the universe to approximately 50 or so stocks.
Here are 5 stocks that meet these criteria:
CELL - Brightpoint, Inc.
CNL - Cleco Corp.
CVI - CVR Energy, Inc.
MTZ - MasTec, Inc.
NM - Navios Maritime Holdings Inc.
Get the rest of the stocks on this list and start using these criteria in your own screening strategies. Sign up now for your free trial of the Research Wizard and start picking better stocks today.
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.
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