Surprise, Surprise: Investment Screening for Earnings & Sales Surprises

Wednesday, Jul 13 2011 by
10
Surprise Surprise Investment Screening for Earnings amp Sales Surprises

In Brief

A forecast-based fundamentals screen based on identifying companies where the earnings and/or sales reported in a company's interim or annual report are not in line with analysts' earnings estimates. An upside surprise - where a company reports higher earnings than analysts predicted - has often been observed to trigger an increase in the stock price.

Background

Analysts produce individual forecasts based on the company's prospects and trends in growth and costs before a company releases its actual earnings. If a company releases a number higher or lower than the consensus (a combination of all the released estimates), this is known respectively as a positive or negative surprise. Positive surprises often happen at the beginning of a turnaround, or a new growth cycle where sales start to accelerate beyond the historical rates, “surprising” the analyst community. As far back as 1968, academic studies have found a strong positive correlation between earnings surprises and stock returns, particularly if the stock reacted positively the day after earnings were announced.

The phenomena, known as "Post Earnings Announcement Drift" finds that these stocks tend to outperform the market for the next 6-12 months.This is generally attributed to the fact that analysts are slow to revise their forecasts and the market does not fully react to the information about future growth conveyed by the earnings surprises. 

Definition of a Forecast Surprise Screen 

The following illustrative Earnings Surprise Screen combines a number of the criteria used by researchers in this area – these elements could be combined to varying degrees.

  • Utilities are excluded since their revenue growths are typically more predictable than those for industrial firms (financial firms are also excluded)
  • A positive earnings surprise up 5% and above industry average
  • A positive sales surprise up 5% and above industry average. This provides an added measure of reliability as it’s usually more difficult/unusual for companies to tinker with sales vs. earnings and because sales growth is seen as more sustainable than cost reduction.
  • Trailing 12 months sales greater than £25 million – This helps ensure that the surprise isn’t large simply because it’s coming from a low base.
  • Average daily trading volume greater than 100k & market capitalisation above £25 million - This eliminates small, thinly traded stocks to which investors are unlikely to pay much attention (Jegadeesh's work used a share price above $5).
  • Market…

Unlock this article instantly by logging into your account

Don’t have an account? Register for free and we’ll get out your way

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. ?>


Do you like this Post?
Yes
No
10 thumbs up
0 thumbs down
Share this post with friends




1 Comment on this Article show/hide all

trader A Trader B 2nd Sep 1 of 1

Excellent

| Link | Share

What's your view on this article? Log In to Comment Now

You can track all @StockoChat comments via Twitter


About Stockopedia Features

Stockopedia Features

Stockopedia Features covers in-depth stories on strategies, companies and themes that are relevant to online investors. Investing is hard work. We don't try to over-simplify complex concepts - we prefer to try to help you navigate the detail.  more »


Stock Picking Tutorial Centre



Let’s get you setup so you get the most out of our service
Done, Let's add some stocks
Brilliant - You've created a folio! Now let's add some stocks to it.

  • Apple (AAPL)

  • Shell (RDSA)

  • Twitter (TWTR)

  • Volkswagon AG (VOK)

  • McDonalds (MCD)

  • Vodafone (VOD)

  • Barratt Homes (BDEV)

  • Microsoft (MSFT)

  • Tesco (TSCO)
Save and show me my analysis