10 shares to watch for big earnings surprise
There is no shortage of evidence to show that most investors (and analysts) are pretty hopeless at forecasting how companies will perform. The equity strategist James Montier once warned that using forecasts as part of the investment process was like tying one hand behind your back before you start.
But while it's easy to knock flimsy forecasts, there's no disputing that most of us take more than a passing interest in them. But rather than blindly following the views of analysts, there are ways of using forecasts to potentially better effect. One of them is to look for companies that are actually beating expectations by wide margins.
Everyone loves a surprise
Earnings surprises have traditionally been very desirable in the stockmarket. For a start, they make companies and their analysts look good. For investors, they've been noted for causing an immediate spike in a share price, and that positive price momentum can carry on for many months.
Part of the problem, however, is that companies and analysts know this. In the United States in particular, it has become common for firms to lower expectations ahead of results, only to pull out much better numbers on the day.
But while some companies have cottoned on to the power of earnings surprises, these events can still be important to investors.
Over the past 20 years, research has found that earnings surprises do lead prices to drift upwards over time. It's caused by investors being slow to react to unexpected good news - particularly in smaller stocks that are less well covered by analysts. As more investors get to grips with the full meaning of an earnings surprise, share price momentum takes over.
Among those that have used these rules in their trading strategies are well known students of the market, such as Josef Lakonishok, David Dreman and Richard Driehaus.
To varying degrees, all of them have adopted earnings surprises as an indicator of improving sentiment towards a stock. The most recent research shows that surprises are even more powerful when firms are beating both their earnings and sales forecasts.
Screening the market for earnings surprises
At Stockopedia we model a strategy based on finding companies that are producing the strongest earnings and sales surprises. It has been a very strong long-term performer. After a slow start to 2018, there has been a sharp uptick in performance in recent weeks.
Source: Stockopedia Past performance is not a guide to future performance
As the name suggests, this screening approach looks for strong earnings and sales surprises from the very latest financial results. In this screen we have searched for both small and mid-cap shares.
|Name||Mkt Cap £m||EPS Surprise % - Last Interim||Sales Surprise % - Last Interim||EPS Surprise % Last Year||Sector|
|Bloomsbury Publishing||135.6||100.7||6.36||7.95||Consumer Cyclicals|
|Capital Drilling||52.4||40.7||42.7||40.7||Basic Materials|
|Domino's Pizza||1,697||12.3||9.27||6.71||Consumer Cyclicals|
Source: Stockopedia Past performance is not a guide to future performance
The results produce some interesting ideas. Leading the list by quite a distance is the oil and gas group Genel Energy (GENL), which recently issued a much more upbeat assessment of its position, with improving cashflow. That coincided with broker upgrades as analysts reworked their numbers following the earnings surprise. Rising oil prices may also account for the presence of oil services firms like Hunting (HTG) and the much smaller firm, Capital Drilling (CAPD).
Elsewhere in the list, the companies range widely from the inkject technology company Xaar (XAR), which has faced industry pressure in recent times, to the Harry Potter publishing group Bloomsbury (BMY). Others include publisher Future (FUTR), metals processing specialist Vesuvius (VSVS), energy supplier Yu (YU.) and Domino's Pizza (DOM).
Making sense of earnings surprises
While earnings forecasts attract suspicion from some investors, it's undeniable that earnings surprises regularly catch the attention of the market. As part of a strategy, they could be a useful pointer to firms that are either recovering from a setback or are consistently advancing ahead. In economic conditions where company earnings trends are under the spotlight, it appears that those beating expectations are being rewarded.
Interactive Investor's Stock Screening series is written by Ben Hobson of Stockopedia.com, the rules-based stockmarket investing website. You can click here to read Richard Beddard's review of Stockopedia.com and learn more about the site.
Interactive Investor readers can enjoy a completely FREE 14-day trial of Stockopedia by clicking here.
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.
*No fee for publication is involved between Interactive Investor and Stockopedia for this column.
About the Author
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"
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