“Ahead of Expectations” - three of the most powerful words in investing

Successful investing isn’t about being right — it’s about being right at the right time. History is littered with examples of investors who were right, but at the wrong time. As the saying goes, "The market can stay irrational longer than you can stay solvent”. One recent story typifies this issue. Ted Aronson was running $10bn in an underperforming US value investing fund from 2011 to 2020. “Our record for the last five years sucks” he said as his investors gave up on him and he closed up shop. Of course, all those value stocks he owned came right back into vogue within months of his fund closing.

So the ideal investment strategy is to avoid the opportunity cost of sitting on underperforming shares that are going nowhere. If you could pinpoint undervalued shares at the exact moment when the market begins to wake up to them, wouldn’t that be something?

The Catalyst: 'Ahead of Expectations'

Three simple words: "ahead of expectations" can be game changing for share sleuths seeking to be right at the right time. Investors that read all the trading updates and results announcements from the RNS (regulatory new service) are always on the lookout for catalytic moments - and these three words can mark them.  

Announcements like these are signals that the analyst community, who set the earnings estimates for a company, are well behind the curve. When low expectations are beaten in undervalued shares, share price fireworks can follow.   It's even better if the announcement is "significantly" or "materially ahead of expectations". 

Normally share prices jump on such news which of course is deeply off-putting. “Damn, I knew that was a good stock” you think to yourself, before sulking off to find something else that hasn’t risen. Big mistake.

The Drift: share prices continue in the same direction

The market can be quite slow to fully revalue shares that have announced a surprise on the upside. While a first day jump is common, what’s less well understood is that shares tend to continue to rise in the same direction over the coming weeks and months. This phenomenon, known as the Post-Earnings Announcement Drift (PEAD), is well-documented in academic research.

In simple terms, investors tend to under-react to an upside surprise. The first day jump often isn’t enough, and a share price trend begins in the same direction for the next few months to the next year. In fact, research by Brandt in “Earnings Announcements are Full of Surprises” suggests that it’s not just about the earnings surprise. The stocks that jump the most in price around earnings days tend to see the strongest drifts in that continued direction - on average gaining 8% over the next 6 months.

What’s more, surprises to the upside have been shown to be “serially correlated”. This means that one “ahead of expectations” announcement may be likely to follow another within the next few months. So share prices often jump on the announcement, drift upwards, then consolidate, then do the same thing all over gain. This may start to carve out what Nicholas Darvas, the famous ballet-dancing stock market millionaire, called a “box pattern”.

Greencore as a classic example

Let’s have a look at Greencore (LON:GNC) - the manufacturer of supermarket own brand convenience foods as an example. Greencore is the top performer in this year’s NAPS Portfolio, having risen 120% year to date. But it all began in October 2023 when it announced that it’s full year operating profit would be “ahead of current market expectations”. That day the share price jumped 22% from 69p to 84p, but over the next few months the shares would drift up and up towards 110p.

The company followed up with a couple of positively framed “in-line” trading statements in November and January, but the outlook grew more bullish through 2024. A series of three “ahead of expectations” announcements between July and December powered the shares higher all the way to 211p. There has been a 200% gain in only 14 months from the first “ahead of” announcement, and the stock is  flagged as one of the “clearest trending mid-caps” in the market, which may be a sign of further gains to come.

Low expectations in value stocks lay the foundations

Greencore seems so dull. Branded convenience foods for supermarkets? Really? These are the kinds of stocks that private investors and fund managers overlook, while chasing biotech and AI stories. But this is exactly the kind of company that the great investors, such as Peter Lynch, would get excited about.

“A company that does boring things is almost as good as a company that has a boring name, and both together is terrific.” Peter Lynch.

So what’s been going on at Greencore? Well the business has been going through a real strategic change process. Through 2023 it exited low-margin contracts, sold off their ingredients trading business, consolidated their soup production to a single site and improved capacity utilisation. This real transformation, as well as a share buyback scheme, have driven greatly improving profitability in 2024.

Contrary to popular belief, it’s often inexpensive value stocks like Greencore, rather than premium growth stocks, that respond the best to ahead of expectations announcements. Value stocks typically suffer from low expectations due to suppressed share prices and limited broker coverage. When good news finally comes, market expectations often fail to adjust quickly enough. If you are an “ahead of expectations” seeker, it pays to be a value investor.

Three words point the way to the multibagger

Any of you who followed the work we did on multibaggers last year will know that most of the market's biggest winners delivered a string of “ahead of expectations” announcements at the pivotal moment.  Games Workshop (LON:GAW), which this week was elevated to the FTSE 100, began its revaluation from a value stock to a growth stock with exactly these three words. The share price has grown 27x since those three words were first announced.

Often “ahead of expectations” announcements can be pointers of pending “operating leverage” - where sales and margins are expanding simultaneously. When this happens, the P/E multiple can expand too. Small changes across all three factors can generate a “triple whammy” effect on the share price. It’s worth refreshing yourself about the financial engines of multibaggers in our Academy, as these insights really matter.

How do you find “ahead of expectations” stocks?

Well, you can just read all the trading statements and results statements daily. Navigating RNS (the London Stock Exchange's regulatory news service) can be rather unwieldy as there are so many announcements about holdings and NAVs and dealings, so you do need some dedication to filter the signal from the noise. We are currently working on some upgrades in this area, and I’m confident we’ll be making this a lot easier for news readers going forwards.

But the saving grace is that we’ve got a terrific editorial team here at Stockopedia who do the scanning for you. Graham, Megan, Mark and Roland plough through company results in the “Daily Stock Market Report” and identify companies trading ahead of (and god forbid below) market expectations in real time.

The tabulated summary at the top of the report is hugely time-saving. Just this Monday I spotted that Synectics (LON:SNX) (one of the stocks I identified among the clearest trending small caps in the UK) announced that it was ahead of expectations again - and popped up another 12% on the day. This is on top of its previous “materially ahead of expectations” announcement on 16th September, which brought the shares back to life and broke them out of a consolidation zone. If you’d invested the day after that first announcement, you’d already be sitting on a 48% gain in less than 2 months.

It’s worth remembering that UK stocks normally report earnings only six monthly, unlike in the USA where they report quarterly. We actually receive far less official “earnings surprise” information than US investors. Our information comes out as much in trading statements as it does in results. So keen news and daily report readers really do have an edge in UK stock markets. If you want to get “ahead of the numbers”, and frankly ahead of the StockRanks, staying alert to these catalytic moments in news really can make a difference to your investing results.

I'm sure there are many eagle-eyed RNS readers reading this - so please do highlight any shares that you’ve seen significantly ahead of expectations (that you think are at catalytic moments) recently in the comments below.