Big profit upgrades make these 10 shares worth watching

Earnings season in the UK doesn't have the same headline-grabbing appeal as it does in the United States. But make no mistake, hits and misses in UK corporate earnings command the attention of analysts and investors everywhere.

Analysts of course, are at the coalface when it comes to forecasting how much companies will make in sales and profits. It's their job to study financial reports in detail, speak to management, judge performances and adjust forecasts accordingly.

This is a notoriously difficult thing to do, and, as a result, analyst research has a fairly mixed reputation among investors. Some see it as vital because the consensus - or average - opinion of analysts is a way of benchmarking a company's performance. It's the best (or perhaps least-worst) way of forecasting how a stock is likely to perform.

Yet others are much more sceptical. Equity strategist James Montier once noted: "analysts are terribly good at telling us what has just happened but of little use in telling us what is going to happen in the future."

Indeed, some worry about the credibility of company research and whether analysts can really be objective. Of all the thousands of stock recommendations made each year, only a small minority ever advise selling stocks. It suggests that analysts are over-optimistic and herd together when it comes to making forecasts. At worst, there are suggestions that this positivity is influenced by the need to stay friendly with management (and perhaps secure lucrative future work) rather than issuing balanced opinions.

How to read the minds of analysts

So can you rely on anything that analysts say? Academic studies show that you can, but you have to be smart about the way you do it. Rather than accepting stock research at face value, 'analysis of analysts' has revealed hidden signals that are much more useful to investors.

One is to look closer at those stocks that are attracting the greatest level of revised earnings forecasts. Strong changes in sentiment, evidenced by large numbers of brokers upping their forecasts, has been found to be a useful sign.

Back in 2006 two academics, Phillip McKnight and Steven Todd, found that a portfolio of 'earnings upgrade' stocks routinely produced positive returns. They claimed this was caused by the fact that forecast upgrades can take up to a year to make a full impact on share prices. They suggested that this was because investors were much more likely to take a wait-and-see approach to those upgrades.

Screening for upgrades

With this in mind, this week's screen for Interactive Investor looks for companies attracting the highest levels of earnings-per-share upgrades over the past month, both for the end of the current financial year (FY1) and for the next financial year (FY2). It also takes into account the number of brokers for each stock, and the number of earnings upgrades.

The results are wide-ranging in terms of sector and size, with private equity group 3i leading the list with double-digit earnings upgrades for the next two years over the past month. Others include the specialist software testing mid-cap, Keyword Studios and the premium soft drinks and mixers company, Fevertree.

Interestingly, there's a slight bias towards industrial and engineering stocks, with companies like Spirax-Sarco, Vesuvius and Electrocomponents. In turn, airlines and holiday stocks like easyJet, Wizz air and On the Beach are also finding favour among analysts.

Analyst research divides opinion among investors. There is no doubt that forecasts can be helpful in assessing stocks, but the accuracy and credibility of some research is occasionally weak.

For investors tempted to use these forecasts, evidence suggests that the highest earnings upgrades among the consensus of analysts is one of the most useful signals. These stocks have been shown to benefit from price momentum caused by investors being slow to react to sharp increases in earnings forecasts. In the busy weeks of earnings season, taking a different approach to analyst research could make it much more useful.

About Stockopedia

Interactive Investor's Stock Screening series is written by Ben Hobson ofStockopedia.com, the rules-based stockmarket investing website. You canclick here to read Richard Beddard's review of Stockopedia.com and learn more about the site.

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It's worth remembering that these and other investment articles on Interactive Investor are simply for generating ideas and if you are thinking of investing they should only ever be a starting point for your own in-depth research before making a decision.

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Ben Hobson is Investment Strategies Editor at Stockopedia.com. His background is in business analysis and journalism. Ben researches and writes regularly on investment strategy performance and screening ideas for Stockopedia.com. He is the author of several ebooks including "How to Make Money in Value Stocks" and "The Smart Money Playbook"

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.