With company earnings season in full swing and London markets displaying signs of improving confidence, we thought we'd share the impressive performance of one of our Momentum screens, which tracks those companies that analysts think are poised for a surge in earnings. 

Of course, as we have discussed in the past, paying too much attention to what analysts have got to say about company stocks is fraught with risks. Broker recommendations (produced by in-house teams of analysts) on whether clients should buy, sell or hold stocks are widely reported in the media but the value of these recommendations is hotly debated. Indeed, research tends to suggest that stock pickers who follow broker recommendations too closely are on a hiding to nothing! 

However, amid the barrage of broker notes and reports, there are a few nuggets of information that can prove useful – earnings upgrades. Scrutinising the market for stocks that are attracting growing confidence among analysts is arguably a far more effective way of using all this information. To support that claim, our Earnings Upgrade Momentum Screen is currently flying – outperforming all of our 63 screens and up an astonishing 31.6% since last December against 11.1% for the FTSE 100.

The problem with brokers 

Among seasoned investors and academics alike, the issue of broker recommendations has a habit of dividing opinion. Research by Jegadeesh, Kim, Krische and Lee over the period 1985-1999 found that sell-side analysts rarely made strong-sell recommendations and this chimes with the theory that analysts have historically exhibited a strong upward bias. This is because most sell-side analysts work for brokerage houses which often have strong investment banking franchises, creating a potential conflict of interest when firms act as investment bankers to the companies their analysts cover. 

Since that research was conducted a raft of legislation has been introduced on both sides of the Atlantic – including the EU's Markets in Financials Instruments Directive (MiFID) – to try and fix the problem. Although this appears to have had some impact, recommendations have still remained relatively optimistic, with research by Jegadeesh and Kim in 2006 indicating that analyst recommendations retain a significant element of favourable bias

But hang on… 

Rather than scrutinising every word of broker recommendations, investors could do better by watching for when these analysts have a change…

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