After a lacklustre performance last year it looks like the brakes have been released on the UK's mid and large cap indexes. The FTSE 100 and FTSE 250 have enjoyed respective gains of around 7.2% and 9.4% so far in 2015. After 12 months of gazing enviously across the Atlantic at soaring US stock markets, it appears that these UK wallflowers are taking to the floor.

For investors considering ways of riding this recent momentum it could be worth taking note of those stocks that pulled off the biggest earnings surprises this earnings season. While broker forecasts can be notoriously inaccurate, research shows that stocks that beat earnings estimates by wide margins often see their prices rise over the coming months (and they tend to keep on surprising, too).

Momentum triggers

Academics observed this type of 'earnings momentum' as far back as the late 1960s. Like other momentum triggers - such as earnings forecast upgrades and 52-week highs - it's thought that positive surprises are insightful because they prod at the behavioural flaws of investors and analysts.

In a nutshell, onlookers tend to react slowly to the full implications of a surprising financial performance. Studies that have found that company analysts can take as long as six months to incorporate earnings and revenue surprises into their forecasts. This tardy response creates so-called post-earnings announcement drift, where share prices often take a period of between three and 12 months to fully reflect the earnings news. Not only that, but some evidence suggests that companies that have surprised the market in the past are more likely to do so again in the future.

Earnings surprises were famously employed as buy and sell signals by US investor Richard Driehaus, who delivered compound annual returns of 30% in the 12 years after starting his fund in 1980. More broadly, a 2008 study by Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School found that momentum in general had been a consistently profitable strategy for over a century despite periodic reversals of fortune. So investors should take note.

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About the Author

Ben Hobson

Premium Member

Stockopedia writer, editor, researcher and interviewer!

1 comment

WarrantStar

Very interesting. It's always good to know that a screen has the benefits of both academic research & success in practice, to back it up.
Based on this article I have made two new screens and saved them in my screens. They are "Earnings Surprises" & "Sales Surprises" I'll have a look through the companies that they come up with and check out whether I think any of them are worth investigating further and worth investing in..
Thanks.

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Mkt Cap £m

EPS Surprise % Last Year

Value Rank

Stock Rank™

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Burford Capital

291.5

60.8