In his book
Contrarian Investment Strategies: The Next Generation
, David Dreman says that the stock market is driven by surprises,
and that one of the greatest sources of surprises is earnings
reports. Dreman found that analysts' estimates of companies'
earnings are rarely on the mark, but that Wall Street nevertheless
gives their forecasts a lot of credence. That means earnings
reporting days often result in reassessments of a company's
prospects -- which can mean significant shifts in its stock price.
With first-quarter earnings season upon us, a big question is which
stocks will get a bounce on earnings day, and which will take a
hit. Of course, there's no way to know for sure, but Bespoke
Investment Group recently offered some interesting research on the
Bespoke compiled a list of the stocks that have, over the past
posted the best average one-day returns on earnings
. The biggest winner: Intuitive Surgical (
), which has gained an average of 8.18% on earnings reporting days
over the past 10 years.
After reading Bespoke's list I thought it would be interesting to
see which of the earnings-day-bounce firms get approval from my
Guru Strategies, each of which is based on the approach of a
different investing great. To be clear, I don't think it's wise to
invest in a company shortly before earnings day solely because it
has strong past earnings day results -- a firm's fundamentals and
financials are what matter most to me. But, if a company has the
financial strength and fundamental soundness needed to pass one or
more of my models, and has a history of earnings day bounces, it
might present a chance to get a good stock with a bit of a
Interestingly, few of the stocks on Bespoke's list passed muster
with my models. Here's a select few that do get high marks:
Dolby Laboratories (
This San Francisco-based firm was a pioneer in the audio arena
because of its noise reduction technologies. Today, Dolby licenses
its technologies to companies that make such products as DVD
players, computers, digital televisions, portable media devices,
and gaming systems. Its products are also used by movie theaters
and broadcasting companies.
Dolby, which is expected to announce first-quarter earnings in late
April, has been a very strong performer on earnings announcement
days over the past decade, averaging a 6.87% gain on those days.
More importantly, the stock currently gets strong interest from my
Peter Lynch-based Guru Strategy.
My Lynch approach considers Dolby a "fast-grower" -- Lynch's
favorite type of investment -- thanks to its 39.5% long-term
earnings per share growth rate. (I use an average of the three-,
four-, and five-year EPS figures to determine a long-term rate.) To
find growth stocks selling on the cheap, Lynch famously used the
P/E/Growth ratio, which divides a stock's price/earnings ratio by
its historic growth rate. The rationale: It's okay to buy stocks
with higher P/Es, so long as they are producing sufficient growth.
The model I base on Lynch's writings looks for stocks with PEGs
below 1.0 (and preferably below 0.5).
Dolby is an example of a strong stock that might be considered too
pricey based only on its P/E, which is currently about 29. But when
you consider its stellar growth rate, the stock is still a good
buy, according to this model, with a PEG of just 0.74.
Another reason this model likes Dolby: The firm appears to be very
well financed, with a tiny 0.5% debt/equity ratio.
Universal American Corp (
Universal American and its subsidiaries offer a variety of
healthcare products, including traditional health insurance,
Medicare managed care plans, and Medicare prescription drug
benefits. The Rye Brook, N.Y.-based company's primary customer base
is senior citizens. The firm, which is expected to announce
earnings in late April, has averaged a 4.6% gain on earnings
announcement days over the past decade, according to Bespoke.
There's been a lot of talk about how the new healthcare bill will
impact Medicare-related firms, but Universal's shares have held up
pretty well in the past couple months. My Lynch-based model thinks
it's a bargain at its current price. It considers the firm a
"stalwart" -- the type of large, steady firm Lynch found offered
protection during downturns or recessions -- because of its 17%
long-term growth rate and high ($5 billion) trailing 12-month
sales. The firm's 9.7 P/E and that growth rate make for a PEG of
just 0.57, easily passing the key Lynch model test.
Because financial companies inherently carry a lot of debt, Lynch
didn't use the debt/equity ratio to gauge their financial health.
Instead, he used the equity/assets ratio and the return on assets
rate. The model I base on his writings looks for E/A ratios of at
least 5%, and ROAs of at least 1%. At 38% and 3.66%, respectively,
Universal blows those targets away.
Universal also earns extra points for passing one of my Lynch-based
model's bonus tests -- net cash position. Lynch defines net cash as
cash and marketable securities minus long-term debt; a high net
cash/price ratio (above 30%) dramatically cuts down on the risk of
a security. At 32.9%, Universal passes the test.
ITT Educational Services (
This private education firm offers a variety of post-secondary
degree programs, most of which focus on technology-related fields.
Based in Indiana, it operates more than 100 technical institutes in
37 states, teaching more than 60,000 students. ITT has averaged an
earnings day bounce of almost 5% over the past decade, according to
ITT gets high marks from two of my guru-based models, those I base
on the approaches of Warren Buffett and Joel Greenblatt. My
conservative Buffett-inspired model looks for firms that have
consistently upped EPS over the past decade, and that have
manageable debt, strong free cash flows, and high returns on
equity. ITT has increased EPS in each year of the past decade,
could pay off its $150 million in debt in about half a year given
its $289 million in annual earnings, and has a free cash flow per
share of $7.20, all of which are plenty good enough to pass muster
with the Buffett approach. ITT also has generated a 39.4% return on
equity over the past decade, a sign of both strong management and
the durable competitive advantage Buffett is known to seek.
My Greenblatt-based model, meanwhile, is inspired by the remarkably
simple two-variable approach that Greenblatt, a successful hedge
fund manager, revealed in his Little Book that Beats the Market.
This approach ranks all stocks by return on total capital and
earnings yield, and looks for those with the best combined
rankings. ITT's 11.91% earnings yield and excellent 147.27% return
on total capital make it the 17th-best stock in the market,
according to the Greenblatt-based model.
Disclosure: I'm long DLB, UAM, and ESI.