Second-quarterearnings season was a bit of a bust.
Althoughearnings remain at an all-time high, the pace of earnings
growth continues to look weak. Earnings growth is up just 3% from
lastyear , a small improvement from the first quarter's 2.6%gain
and the 2.8% average for the past fourquarters .
The headlines reflected that disappointment, with stories
about the biggestblue chips struggling with the weak
globaleconomy and falling short of expectations. That includes
misses from bellwethers like
Google (Nasdaq: GOOG)
Microsoft (Nasdaq: MSFT)
But in spite of some earnings headwinds, there were a number
of companies that bucked the trend and delivered big earnings
surprises. For instance, take
Facebook (Nasdaq: FB)
, which delivered a 44%earnings surprise last month that sent the
company's share price soaring.
But if you missed out on that firstleg higher, don't worry,
because according to a little-known and understood pattern, there
is still moreupside in Facebook.
According to the post-earnings drift, firms with good
quarterly earnings reports tend to see returns drift upward for
at least 60 days after their announcements. Similarly, firms that
report disappointing earnings tend to drift lower for a similar
You can see that pattern play out in Facebook, withshares
initially jumping to $34 before drifting another 20% higher in
the next three weeks.
A strong earnings surprisewill have an immediate impact on a
company's share price as short-term players scramble to be the
first tomarket . But that is merely the firstwave in a series of
biggerwaves , as larger long-term investors likehedge and
mutualfunds shiftmoney into new targets based on new information.
That can keep billions incapital flowing into astock for weeks
and months after an earnings surprise.
The post-earnings drift enables investors to bypass the
guesswork of identifying which companies will produce earnings
surprises and focus on simply buying ones that have already
surprised to the upside instead. That means missing the first,
big move higher, but it also increases the likelihood of a
profitableinvestment or trade.
Below is a list of seven S&P 500 companies that delivered
big second-quarter earnings surprises.
From the group I have chosen to highlight
Forest Laboratories (
because of itsbullish growth projection and
Chesapeake Energy (
for its attractive valuation.
Forest has looked solid in 2013, with shares up 23% on the year.
The branded drugmaker got a big boost in late June with record
fourth-quarter results that produced earnings of 28 cents per
share, well ahead of theconsensus estimate of 7 cents. Forest is
in the early stages of a long-term growth cycle, expected to
increase earnings by an average of 36% annually in the next five
years. But in spite of those high expectations, Forest's
PEG ) ratio
of 1.02 is a discount to its peer average of 1.21 and in line
with thebenchmark for value of 1.
Chesapeake is looking like one of the bestturnaround stories of
2013, with shares up a market-beating 51% on the year. That comes
on the heels of a busy 2012 when activist billionaire Carl Icahn
took a large stake and agitated for change, leading to the firing
of the company's founder and longtimeCEO and thesale of assets to
raisecash andsupport liquidity . Those strategic adjustments have
paid off big, with Chesapeake reporting a 31% earnings surprise
in its most recent quarter. Chesapeake is projected to increase
earnings by 30% annually in the next five years and carries a
1.3%dividend yield .
Risks to Consider:
Stocks that deliver big earnings surprises tend to carry
higher expectations and trade at higher valuations. Any future
earnings misses or weaker than expected forecast can weigh
heavily on shares that have rallied on bullish growth
Action to Take -->
In spite of Chesapeake's impressive 51% gain in 2013, shares
still lookundervalued , trading with a forwardP/E
(price-to-earnings) ratio of 16. If Chesapeake traded with the
same forward P/E of 18 as its peers, shares would climb another
13%, making Chesapeake a buy below $27.50. Forest Laboratories is
expected to increase earnings by 36% annually in the next five
years, targeting full-year earnings of $4.51 in 2018. If Forest
simply traded with the same valuation as its peers, that would
send shares soaring to $72, a 67% premium to current levels.
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