It is not surprising that before an earnings season, every investor looks for stocks that can beat market expectations. This is because investors always try to position themselves ahead of time and look to tap stocks that are high-quality in nature.
In this regard, we ran a screener that yielded stocks PENN Entertainment Inc. PENN, Boise Cascade BCC, Dycom Industries DY, Silicon Motion Technology SIMO and Unity Software U as the likely winners on the earnings beat potential.
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 has been 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 when judging the true health of a company.
On the other hand, after much brainstorming and analysis of companies’ financials and initiatives, Wall Street analysts project the 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 perception. 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 higher.
How to Find Stocks That Can Beat?
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 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 apply the same secret to execute yet another earnings beat in its next release.
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 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 or 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 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 has narrowed down the universe from over 7,700 stocks to only 13.
Here are five out of 13 stocks:
PENN Entertainment:The Zacks Rank #1 company adopted its current name in 1994 when it became publicly traded. PENN Entertainment is a multi-jurisdictional owner and operator of gaming and racing facilities with video gaming terminal operations and a focus on slot machine entertainment. The company’s portfolio is geographically diverse and includes a broad set of regional properties. You can see the complete list of today’s Zacks #1 Rank stocks here.
The average earnings surprise of PENN for the past four quarters is 120.11%.
Boise Cascade: The Zacks Rank #2 (Buy) company is one of the largest wood products manufacturers and a leading U.S. wholesale distributor of building products, headquartered in Boise, ID.
The average earnings surprise of BCC for the past four quarters is 40.83%.
Dycom Industries:The Zacks Rank #1 company is a specialty contracting firm operating in the telecom industry.
The average earnings surprise of DY for the past four quarters is 24.96%.
Silicon Motion Technology: Silicon Motion Technology Corporation is a leading developer of microcontroller ICs for NAND flash storage devices. The stock has a Zacks Rank #1.
The average earnings surprise of SIMO for the past four quarters is 18.61%.
Unity Software: The company provides a platform to develop, deploy and grow games and interactive 3D experiences across mobile, PC, console and extended reality.The stock has a Zacks Rank #1.
The average earnings surprise of U for the past four quarters is 7.37%.
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Silicon Motion Technology Corporation (SIMO): Free Stock Analysis Report
PENN Entertainment, Inc. (PENN): Free Stock Analysis Report
Dycom Industries, Inc. (DY): Free Stock Analysis Report
Boise Cascade, L.L.C. (BCC): Free Stock Analysis Report
Unity Software Inc. (U): Free Stock Analysis Report
This article originally published on Zacks Investment Research (zacks.com).