At the end of every year, major publications like the Wall Street Journal produce a list of stocks with the biggest gains. What do these stocks have in common? Most of them experienced a surge in earnings that greatly surpassed expectations - and the stock subsequently soared. Another term for this surge is positive earnings momentum.
On the flip side, stocks that fell the most during the year experienced negative earnings momentum. To sum it up:
* Good earnings begets more good earnings begets higher share prices
* Bad earnings begets more bad earnings begets lower share prices
As investors, our goal is to line our portfolios with as many stocks experiencing positive earnings momentum as possible. How do we do that? First we must understand the dynamics of earnings momentum.
Dynamics of Earnings Momentum
Publicly-traded companies are large organisms that include many employees, products, buildings, equipment, etc. When they are experiencing positive earnings momentum, it means that most everything is going right; i.e. a great management team, first rate products and services, happy employees and delighted customers.
These aspects have a self-reinforcing quality that will keep the company headed in the right direction for an extended period of time. The result being a string of earnings reports well above expectations and a booming stock price.
However, the company experiencing negative earnings momentum will behave in the opposite way; i.e. a poor management team, inferior products and services, disgruntled employees and dissatisfied customers fleeing to the competition. As you know, this is very bad for the stock price.
I like to think of a company as a large freight train stretching as far as the eye can see. When things are going well the train just keep rolling down the track. There is a positive rattle and hum to that train that everyone enjoys.
Now imagine the conductor notices that the train is going in the wrong direction. The train is headed south when it needs to go north. Now ask yourself how much time and energy does it take to stop that train? Even worse, how long will it take to back the train up to a spot where it can turn around?
The same is true for a large company that's headed in the wrong direction. Do you think it can be turned around in one quarter? Or two? History shows that not to be the case. Yet too many of us are content to hold onto stocks that have earnings disappointments only to see share prices plummet. I can not say this emphatically enough…
SELL ALL COMPANIES WITH NEGATIVE EARNINGS SURPRISES…IMMEDIATELY!!!
How to Find Companies with Positive Earnings Momentum?
The easiest way to find stocks with positive earnings momentum is through a stock screener that can find companies with the following beneficial attributes:
* Average EPS Surprise over the last four quarters: You want the average surprise for stocks experiencing exceptional earnings momentum to be at least 10%
* Previous EPS Surprise: You want this to be 10% or better too.
* % Change EPS: Make sure that the stock is not only beating estimates, but is achieving year over year growth. You can set this as low as 0%, but it should probably be higher
* Zacks Rank: For those customers who subscribe to our premium services, I would highly recommend limiting the search to stocks with a Zacks #1 Rank (Strong Buy) or Zacks #2 Rank (Buy).
Four Stocks That Make the Grade
Using the criteria above on the Zacks.com stock screener, I came up with a number of stocks that are experiencing robust earnings momentum. Here are some of the stocks that appeared on that list:
Flour (FLR)
Mastercard (MA)
Monsanto (MON)
Owens-Illinois( OI)
Beyond the stock screener, another very useful tool to research the state of earnings momentum is the Price and Consensus chart, which is only available on Zacks.com. Below is a link to see that chart for Mastercard. Once there, you can view charts for all other stocks. You want to make sure that the most recent year's earnings estimates are sloping higher. And the chart for Mastercard is as impressive as it gets.
Sunscreen will be slathered on by sun worshipers everywhere. A solid company whose wide range of offerings include sun care products is Schering-Plough (SGP). The company makes and licenses science-based medicines and offers services that help people worldwide live longer, healthier lives.
This healthcare player posted first-quarter earnings per share of 53 cents, topping the previous year’s 42 cents and soaring past the consensus estimate by 47%.
The company’s earnings per share are expected to grow by approximately 14% over the next three to five years. Its return on equity (ROE) of 29% is well above the industry average.
Current full-year 2008 analyst estimates are at $1.52, versus the two months-ago level of $1.42.
A FUN One to Watch
Cedar Fair LP (FUN), with its outdoor water parks, may surge higher this summer. It is a publicly traded partnership headquartered in Sandusky, Ohio, and one of the largest regional amusement-resort operators in the world. The Partnership owns and operates 11 amusement parks, six outdoor water parks, one indoor water park and five hotels.
The company’s fundamentals are not quite as strong as that of the aforementioned. It reported a first-quarter loss of 81 cents per share. However, the loss was narrower than the year-ago loss of $1.02, and the earnings result came in 26% above the consensus estimate.
Given FUN’s fundamentals, the company seems poised for a turnaround this summer. Full-year 2008 earnings estimates $1.11 are up from the two months-ago level of $1.06. Year 2009 projections have also been on the rise.
Additional Ways to Find Companies With Solid Fundamentals
Zacks Custom Screener - This is the place to start to create your own screens where you can search by sector.
Research Wizard - This is where to go to create customized portfolios. About
The Author...
Steve Reitmeister is an Editor at Large at Zacks Investment Research who covers Investment Ideas. For more information, visit www.zacks.com/newsroom/commentary/?id=7797 for the RSS Feed of this article: www.zacks.com/external/rss.php?f=32
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