By now, it is common to all that the latest reporting cycle has been fairly solid with earnings growth on track to be the highest in two years. Total earnings for 319 constituents of the S&P 500 index are up 5.8% on 4.5% higher revenues, with 69.6% beating EPS estimates and 54.5% outpacing revenue expectations. About 41.4% of companies reported ahead of both estimates, as per the Earnings Trends issued on February 8, 2017.
However, investors should note that though the growth picture is brightening, beat ratios are on the lower side. Over 68% beat EPS estimates against 76.7% in the previous quarter, with 74.5% being the four-quarter average and 72.7% being the 12-quarter average, as per the Earnings Trends issued on February 1, 2017.
Though earnings growth momentum should cheer up investors, slowing positive earnings surprise may be worrisome. This is because positive earnings surprise or beat ratios appear to be a better indicator than solid quarterly earnings growth.
Why Is a Positive Earnings Surprise So Important?
Historically, stocks of companies with solid quarterly earnings (on a nominal basis) tank if they miss or merely meet market expectations. After all, a 20% rise (though apparently looks good) doesn't tell you if earnings have been decelerating.
Also, seasonal fluctuations can come into play. If a company's Q1 is seasonally weak and Q4 is strong, it is likely to report a sequential earnings decline. In such cases, growth rates are misleading while judging the true health of a company.
On the other hand, after a whole lot of research and analysis on a company's financials and initiatives, Wall Street analysts project its earnings. They also take a company's guidance into consideration when deriving an earnings estimate. Thus, outperforming that estimate is almost equivalent to beating the company's own expectation as well as the market perception.
Bet on Sector ETF Outperformers
In this regard, investors will definitely tend to bet on sector ETFs that came up with positive surprises even in this troublesome quarter. Below we highlight those sectors and the related ETFs that may fetch you solid returns in the days to come.
As per Earnings Trends,as many as 71.4% of the consumer discretionary companies beat EPS estimates while 61.9% beat revenue estimates.
A strengthening economy, a healing labor market and still-low energy prices probably have gone in favor of economically sensitive sectors like consumer discretionary. Consumer Discretionary Select Sector SPDR ETFXLY - a Zacks Rank #1 (Strong Buy) - should thus be an enticing tool to cash in on the trend.
About 83.8% of medical companies beat EPS estimates while 56.8% surpassed revenue estimates.
Healthcare is one of the most defensive sectors in the U.S market and normally stays steady amid global economic uncertainty. An aging population, high rates of chronic disease, growing demand in emerging markets and product launches are the positives of the sector. Also, the industry may see the de-regulation of the FDA which would, presumably, push drugs to the markets faster. In such a scenario, PowerShares DWA Healthcare Momentum ETFPTH - a Zacks Rank #2 (Buy) can be an interesting option to play the U.S. health care sector.
Nearly 73.3% of the basic material companies beat bottom-line estimates while 60% came ahead of top-line expectations.
Apart from sturdy beat ratios, the broader materials' sector has enjoyed several other tailwinds. U.S. President Trump's pledges to invest in infrastructure activities hugely favored some industrial metals and other materials, which are used as raw materials of infrastructural activities (read: Top Mining ETFs & Stocks of 2016:The Best from a Winner ).
Plus, China's manufacturing activity is looking up. Factory output, a prolonged cause of concern for the Chinese economy, lately entered into the growth zone leaving behind the stretch of contraction. Since the Chinese economy accounts for about half of the global consumption of industrial commodities, the surge in metal and mining stocks is self-explanatory (read: 2017 Brings Luck for China ETFs: Will the Rally Last? ).
PowerShares Dynamic Basic Materials Sector PortfolioPYZ - a Zacks Rank #1 ETF - could thus be a great play now.
About 70.5% of the technology companies beat on EPS while 75% outdid revenue estimates.
The sector has been in the sweet spot since the start of the year thanks to solid earnings reports. Improving overseas demand, technological innovation and the rise of internet of things (IoT) made this sector a winner. PowerShares Dynamic Semiconductors Portfolio ETF PSI has been one of the clear beneficiaries of this trend (read: Semiconductor ETFs Riding High on Q4 Earnings ).
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.