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Zacks Earnings ESP: A Better Method - Analyst Blog

By: Zacks.com
Posted: 1/17/2013 2:57:00 PM
Referenced Stocks:

Finding stocks that are likely to beat their quarterly earnings estimates -- and soar -- is an extremely difficult task. There are plenty of times when a stock beats its estimate but fails to rise -- or worse -- once earnings are released.

A popular technique that many try to avoid this scenario is by hunting for 'earnings whispers.' This process looks to get the inside scoop on analyst estimate revisions ahead of the report in order to detect those that are most likely to unexpectedly beat or miss their earnings consensus.

After all, wouldn't it be great to know which stocks are likely to have earnings surprises ahead of the release date?

And also which stocks are likely to disappoint before their share prices plummet?

We have cracked the code with our new Zacks Earnings ESP system, as it predicts earnings surprises with nearly 7 out of 10 accuracy while offering up a market-crushing 28% per-year return. Read on to learn more about this groundbreaking method and how it could help you both this earnings season, and for years to come.

Zacks Earnings ESP in Focus

This Zacks Earnings ESP (Expected Surprise Prediction) is our proprietary methodology for determining which stocks have the best chance to surprise with their next earnings announcement.

The approach takes into account two important parts of the earnings estimate picture; the 'Most Accurate Estimate' and the 'Zacks Consensus Estimate.'

Once we have these two figures, we compare the Most Accurate Estimate to the current Zacks Consensus Estimate, and the resulting percentage difference between the two equals the Expected Surprise Prediction.

How Accurate is Earnings ESP?  

Earnings ESP has proven to be a very valuable tool for investors seeking stocks that are most likely to beat earnings estimates. In our extensive backtesting, we found that over the past decade, stocks with a positive Earnings ESP and with a Zacks Rank of #1, 2 or 3 ('Strong Buy,' 'Buy' or 'Hold'), produced a positive surprise 70% of the time .

In fact, stocks ranked #3 or better with a positive Earnings ESP only surprised to the downside 21% of the time. This means that in nearly four out of five cases, Zacks Rank # 1, 2, or 3 stocks with positive Earnings ESP met or beat estimates, at least in the ten-year period studied.

Investors should also note that the Earnings ESP strategy must be used in conjunction with the Zacks Rank for truly favorable performance figures. For example, our research has shown that even if you have a favorable Earnings ESP but an unfavorable Zacks Rank, the chance of a positive surprise is slashed and the likelihood of a negative surprise increases drastically.

Meanwhile, if the Earnings ESP number is negative but if there is a neutral to positive Zacks Rank for the stock, obtaining a positive surprise is pretty much a coin flip at 52% of the time. Odds of a negative surprise with this combination of the Zacks Rank and the Earnings ESP stand at 37%, with in-line performances accounting for the rest.

This research suggests that both the Zacks Rank and the Earnings ESP must be at least neutral in order to find the top stocks in a given earnings season. A negative figure in either metric will greatly increase the odds of a surprise to the downside meaning that only a combination of the two can produce truly top stocks for earnings season.

What About on the Short Side?

While the Earnings ESP figure and the Zacks Rank make a great one-two punch for finding stocks that are likely to beat earnings estimates, they haven't been as successful for finding stocks that are likely to miss expectations.

Our research shows that if a stock has both a negative Earnings ESP and a negative Zacks Rank (4 or 5), a positive surprise occurs only 41% of the time with a negative surprise happening 47% of the time. While these figures do suggest that negative surprises are certainly more likely, it obviously isn't as robust of a metric as what investors see on the positive side.

For this reason, we suggest only applying the Earnings ESP in concert with the Zacks Rank to find top stocks that are the most likely to outperform their earnings estimates.

Earnings ESP Results

Now that you know which groups of stocks to focus on to increase your chances of a positive surprise, let's look at the size of the Earnings ESP that has historically generated the best results.

First, just having a positive Earnings ESP produces market beating results. Over the last ten years, using a one-week holding period (stocks were held for no more than one week after they reported), the average annual return was 23.5%. This is in stark contrast to stocks with a negative Earnings ESP, which produced a -9.20% return with the same time filter.

If investors instead take the positive Earnings ESP and also apply a Zacks Rank filter that only looks at stocks that have a 1, 2, or 3, the performance becomes even more impressive. According to our research, over the past ten years using a one-week holding period after the report date, stocks that combined a positive earnings ESP and at least a neutral Zack Rank saw annual returns of 28.3%.

Investors could drill down further into stocks with higher Earnings ESP levels in order to boost their returns as well, showing that a higher figure in this department can have a marked improvement on stock price performance.

For stocks that have an Earnings ESP of at least 1%, the one-week-after-report-date performance jumps up to an annual rate of 29.6%. Meanwhile, an Earnings ESP of at least 2% increases returns up to 31.6% annualized, and then finally an Earnings ESP greater than 3% results in an average annual return of 37.2% .

Beyond that level, we did not see much of an added boost in terms of stock performance above those figures. Furthermore, the sample size for stocks with truly massive Earnings ESP figures is very small, making it even more difficult to get a good reading, even after a decade-long backtest.

Start Using Zacks Earnings ESP in Your Own Trading Today

The next time your stock is about to report or a security on your watchlist is getting closer to the earnings date, be sure to look at its Zacks Earnings ESP and see what your stock's probabilities are of producing a positive surprise. You can find this figure on any stock estimates page, and soon in the Zacks Earnings Center as well.

Or if you want some professional help, we can find the best Earnings ESP stocks for you with the Whisper Trader Run by Jared Levy . This investing service utilizes both the Zacks Earnings ESP metric and the Zacks Rank to find the stocks that are the most likely to beat earnings and outperform the market with stunning levels of accuracy.



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