Earnings Estimates Revision Screen: Why investors should keep an eye on consensus Sales and EPS forecasts

Sunday, Jul 24 2011 by
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Earnings Estimates Revision Screen Why investors should keep an eye on consensus Sales and EPS forecasts

In Brief

A momentum screen based on buying stocks with rising analyst earnings estimate revisions in light of empirical findings that stocks with their estimates revised often outperform the market over at least the next 12 months.

Background

Earnings estimates are created by equity analysts in order to project the growth and profitability of a company on a quarterly and/or yearly basis. In 1969, Burton Fabricand was apparently the first to write about the strong link between estimate revisions and subsequent stock prices, showing that portfolios of stocks selected on the basis of large estimate revisions significantly beat the market over a three month holding period. Following this, in 1979 Leonard Zacks (founder of Zacks Investment Research) published an article entitled "EPS Forecasts - Accuracy is not enough."  He found that "there was no correlation between forecast EPS growth and stock growth… consistent with efficient market concepts”. In contrast, “portfolios of companies whose consensus forecasts underestimated actual actual earnings growth outperformed the market on average”. He concluded that, to achieve excess returns, stock selection must be based on anticipating changes in the consensus expectation, rather than changes in actual earnings. More recently, researchers McKnight and Todd examined a portfolio of European stocks and found that the 20% with the highest net upward revisions outperformed the lowest 20% by over 16% a year. This is a fascinating study and it's well worth a read. This effect was persistent/robust and not concentrated to small stocks, stocks with low analyst coverage, or stocks with low book-to-market ratios. 

How well does it work?

In addition to the results found by McKnight and Todd, the AAII 'Estimated Revenue up 5%' screen is the best-performing screen in its extensive database, up a massive 30% compounded since inception, compared with 2.3% for the S&P 500. Zacks' track record has also been impressive - buying a portfolio of Zacks #1 Rank stocks over the 17 years from 1988 apparently generated an average annual return of 33% versus the S&P 500 return of 12%. 

Why does it work? 

Researchers Barberis, Shleifer, and Vishny suggested that the kind of momentum is rooted in investors’ conservatism bias and the fact that investors do not update their beliefs adequately based on the strength and weight of new information. Interestingly, McKnight’s work found…

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Disclaimer:  

As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested. ?>


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