Screening the market for companies where brokers have recently upgraded their earnings forecasts has proved to be a great investing strategy this year. Ignoring ‘buy’ and ‘sell’ recommendations in favour of watching for positive changes in analyst sentiment with our Earnings Upgrade Momentum screen has delivered a 36% return over five months. But the recent promotion of food delivery business Ocado (LON:OCDO) to that screen raises a couple of interesting questions. With a business model that divides opinion and shares that are a magnet for short sellers, could Ocado be an earnings upgrade Trojan horse?
Last week I wrote about how broker upgrades tend to have a lagging impact on share prices. Rather than just producing a ‘pop’, evidence suggests that the full implications of this type of improving sentiment can sometimes take months to get fully priced-in to a share. This so-called price momentum effect can be triggered by all sorts of events, including upgrades, earning surprises and changes in consensus expectations. But critically, momentum works because investors have been found to react slowly to positive news. Academics Phillip McKnight and Steven Todd, who have studied the impact of broker upgrades, believe this is down to investors adopting a ‘wait-and-see’ approach while they figure out how meaningful the upgrade really is.
For companies to qualify for the Earnings Upgrade Momentum screen, each one needs to have had, in the past month, an earning forecast increase for the next financial year of more than 5%. And with just a few exceptions, all 20 of the shares currently qualifying have enjoyed stellar price improvements in the recent past, contributing to the screen’s impressive performance.
Massive upgrade for Ocado
With a spectacular 222% increase in earnings forecasts in early May, it was little surprise that Ocado shot straight to the top of the screen. Since its controversial IPO in July 2010, when many analysts claimed the 180p flotation price was too rich, its shares have struggled. A spike to 259p in February 2011 was short lived and the stock spent most of last year at well below 100p. Underlying this lacklustre performance is a business that has yet to make a profit from its arrangement to deliver groceries for Waitrose. A long awaited second distribution centre at Dordon in Warwickshire is now operational…
