Both positive and negative earnings surprises, defined as reported earnings that exceed or fall short of analyst expectations, can have enduring long-term effects on stock performance. Therefore, monitoring analysts’ revisions to their earnings estimates can be a beneficial investment strategy. The American Association of Individual Investors (AAII) utilizes various screening methods to identify stocks with upward or downward revisions in earnings estimates. Specifically, AAII tracks screens that focus on firms that have experienced a significant increase or decrease—specifically, by at least 5%—in annual earnings estimates over the last month. These tools utilize consensus earnings estimates from S&P Global Market Intelligence available through AAII’s Stock Investor Pro.
The strategy that focuses on firms with upward revisions of at least 5% has proven to be particularly effective, boasting an average annual gain of 23% since its inception in 1998, significantly outperforming the S&P 500 index, which averaged only 6.6% over the same time period. This disparity highlights the potential profitability of investing in stocks that exhibit positive revisions in earnings estimates. Understanding what drives these estimates, however, is crucial to effectively leveraging this strategy. Earnings per share (EPS) estimates are influenced by a myriad of factors, including sales growth, profit margins, and competitive conditions—all of which analysts assess to formulate their expectations on a company’s future performance.
The crux of stock price fluctuations lies in investor expectations, making the impact of earnings surprises pivotal in stock valuation. When companies report their earnings, the market reacts not just to the actual figures but also to how these figures stack up against consensus expectations. Services like S&P Global and Zacks Investment Research provide valuable insights by compiling and tracking these estimates, which investors can use as a barometer for potential stock performance. It is essential to note that stock prices typically reflect the prevailing consensus earnings estimates; hence, a stock may decline in value even after reporting positive earnings if those earnings fall short of optimistic forecasts.
During earnings announcements, companies typically release their earnings about a month after the ending of a fiscal quarter. This period is closely monitored by investors and financial news outlets, especially for firms that report earnings significantly different from consensus estimates—labeled as earnings surprises. Positive earnings surprises often correlate with substantial gains in stock performance, while negative surprises can lead to prolonged underperformance in stock prices. Studies have indicated that the repercussions of such surprises can linger for up to a year after the announcement, reinforcing the idea that timing plays a critical role in investment strategy. Additionally, larger firms tend to respond to surprises faster than smaller firms due to the greater number of analysts following them, making their stocks more dynamic in terms of price adjustment following unexpected earnings results.
Investor strategies involving earnings estimates are often centered around avoiding stocks likely to report negative surprises while seeking to invest in those trending toward positive surprises. As earlier trends in estimates provide insight into future surprises, the potential for significant upward revisions constitutes a strong indicator of a stock’s upward momentum. Companies may strategically manage expectations by slightly lowering estimates to ensure they can report positive surprises. Historically, studies suggest there are more positive quarterly earnings surprises than negative ones; however, these trends do not uniformly apply to yearly estimates.
AAII’s screening tool is designed to filter stocks with at least five estimates to ensure that revisions indicate a genuine shift in consensus, rather than isolated analyst opinions. The methodology checks for an upward movement in consensus estimates for both the current and next fiscal year. By identifying stocks that have recorded at least a 5% increase in estimates over the prior month, investors can hone in on those expected to outperform. Notably, the analysis of stock performance in relation to earnings estimate changes reinforces the fundamental concept that changing investor expectations directly influence stock prices. To make informed decisions, investors must keep abreast of consensus earnings forecasts and recognize how current stock prices often encapsulate these forecasts.
In summary, understanding and tracking these revisions and earnings surprises provide investors with a framework to enhance portfolio performance through informed decision-making. Positive changes in earnings estimates can herald stock price increases, while negative revisions can spell trouble. Therefore, employing a systematic approach to screening for stocks exhibiting significant upward revisions can build a more rewarding investment strategy. While the AAII’s processed stocks based on earnings revisions do not constitute a direct “buy” list, they offer a compass toward potential opportunities for investors aiming to navigate market volatility. By becoming an AAII member, investors gain access to invaluable tools and insights for optimizing their investment strategies in an ever-evolving market landscape.
