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Market Expectations vs. Results: Tracking Analyst Earnings Revisions

by Wayne A. Thorp, CFA

Market Expectations Vs. Results: Tracking Analyst Earnings Revisions Splash image

The stock market is forward looking. As such, stock prices are established based on expectations of how a company will fare in the future. Over time, stock prices adjust as these expectations change or are proven wrong.

While long-term earnings strength is often a hallmark of companies with solid investment performance, the market appears to have an obsession with short-term performance in the form of quarterly earnings. More accurately, the market focuses intensely on how quarterly results stack up against the market’s expectations. As a result, changes in earnings expectations, no matter how slight, can have a significant impact on a stock’s price—the effects of which can be felt for as long as a year.

Expectations regarding a company’s quarterly or annual earnings typically take the form of earnings per share estimates. These estimates are shaped by many company, industry, and economic forces. They embody an analyst’s opinion of such factors as sales growth, product demand, competitive industry environment, profit margins, and cost controls. Many stock valuation models use earnings and, therefore, slight changes in expectations for future earnings per share or earnings growth can translate into a significant and lasting impact on stock prices.

Investor services such as I/B/E/S, First Call (both of which are now under the Thomson Reuters umbrella), and Zacks provide consensus earnings estimates by tracking the analysts that follow specific companies.

Tracking these expectations and their changes is an important component of stock analysis. In addition, tracking significant revisions can be turned into a rewarding investment strategy.

Screening for Revisions

A time-saving way to identify companies whose consensus earnings estimates have been revised is through screening. AAII tracks multiple screens that look for recent upward and downward earnings revisions. The screens are simple in that they focus only on revisions to current and next fiscal-year estimates without any additional secondary filters for financial strength or price momentum.

The AAII screens focus on the type of revision:

  • The upward revision screen seeks companies with positive revisions—the latest earnings per share estimate for the current fiscal year and next fiscal year is greater than it was one month ago and there have been no downward revisions of the earnings estimate for the current fiscal year as well as the next fiscal year over the last month.
  • The downward revision screen seeks companies with negative revisions—the latest earnings per share estimate for the current fiscal year and next fiscal year is lower than it was one month ago and there have been no upward revisions of the earnings estimate for the current fiscal year and next fiscal year over the last month.

Two additional screens require a minimum 5% increase and decrease in the consensus estimate for the current and next fiscal year, respectively, over the last month. The aim of these screens is to see if the magnitude of the revisions has a greater impact on stocks.

The specific screening criteria for these analyst revision screens are listed at the end of this article.

Screen Performance

The four analyst revisions screens highlighted here are built into AAII’s Stock Investor Pro fundamental stock screening and research database program. Furthermore, the companies passing these screens are posted each month on AAII.com, and the performance of stocks held in the hypothetical portfolios is tracked on-line.

Figure 1 shows the performance of the four estimate revision screens. As it indicates, stocks with upward earnings revisions have clearly outperformed stocks with downward earnings revisions. Changes in stock prices resulting from an earnings revision can be, and often are, felt immediately. Furthermore, studies also indicate that the impact of earnings revisions as well as earnings surprises may persist for as long as a year. Even though the greatest impact on stock price was probably felt in the month the revisions took place, these upward revisions strategies still worked when comparing the current consensus estimate to that of the previous month.

Both upward revision screens have outperformed the large-cap S&P 500 index since the beginning of 1998. As Figure 1 shows, the 5% upward revision screen has generated a cumulative return of 1,121.1% over the period from January 1998 through the end of February 2009, while the S&P 500 is down 24.3% over the same period. By contrast, the largest 30 percentage downward revision and 5% downward revision screens have lost 64.8% and 57.5%, respectively.

Overview of Passing Firms

The characteristics of the stocks currently meeting the criteria of the upward and downward revision screens are presented in Table 1.

Portfolio Characteristics (Median) 30
Largest
% Up
Rev
Stocks
Est
Rev
Up 5%
Stocks
30
Largest
% Down
Rev
Stocks
Est
Rev
Down 5%
Stocks
 
All
Exchange-
Listed
Stocks
Price-earnings ratio (X) 16.2 19.0 6.1 7.8 9.8
Price-to-book-value ratio (X) 2.3 2.3 0.5 0.8 0.8
EPS 5-yr. historical growth rate (%) 2.3 -4.8 13.8 10.6 6.5
EPS 3-5 yr. estimated growth rate (%) 18.0 19.0 11.7 12.0 12.0
Market cap. ($ million) 914.3 541.7 189 522.4 165.8
Relative strength vs. S&P (S&P=0) (%) 66 68 -53 -30 -16
           
Monthly Observations
Average no. of passing stocks 30 42 30 80  
Highest no. of passing stocks 32 160 32 307  
Lowest no. of passing stocks 27 4 29 17  
Monthly turnover (%) 93.1 92.1 90.6 88.5  

Table 2 lists the 10 companies with the largest percentage increase in current-fiscal-year earnings estimates over the last month, along with the 10 companies with the largest percentage decrease in current-fiscal-year earnings estimates over the last month. These screening results are as of March 6, 2009.

Largest % Upward Revisions Current Fiscal Year Next Fiscal Year  
Current
Est
($/Sh)
Est
Range
Mthly
Chg
in Est
(%)
No.
of
Est
(X)
No. of
Revisions
Current
Est
($/Sh)
Mthly
Chg
in Est
(%)
 
 
High Low Up Down  
($/Sh) ($/Sh) (X) (X) Description
         
RADVISION LTD. (USA) (M: RVSN) 0.23 0.40 0.14 928.6 6 6 0 0.33 230.0 videoconferencing
SuccessFactors (M: SFSF) -0.26 -0.22 -0.33 76.3 13 14 0 -0.03 95.7 talent mgmt softw
DG FastChanne (M: DGIT) 0.96 1.50 0.78 36.8 8 7 0 1.44 18.0 digital networks
Myriad Genetics (M: MYGN) 1.97 3.18 1.49 29.5 12 10 0 3.33 45.0 molecular diagnostics
Fidelity National Fin’l (N: FNF) 1.55 2.00 1.25 29.0 6 6 0 1.67 11.9 insurance holding co
Applied Signal Tech (M: APSG) 0.91 0.96 0.85 20.5 6 7 0 0.99 14.9 signals intelligence 
Odyssey HealthCare (M: ODSY) 0.86 0.93 0.80 17.5 8 7 0 0.95 10.2 hospice care
Grand Canyon Educ (M: LOPE) 0.55 0.56 0.53 13.5 7 6 0 0.85 9.4 college education
Indevus Pharm’ls (M: IDEV) -0.52 -0.20 -0.70 13.3 6 1 0 -0.10 42.7 pharmaceuticals
Del Monte Foods (N: DLM) 0.66 0.68 0.65 12.5 7 7 0 0.75 17.0 branded food prods
Largest % Downward Revisions
Advanced Energy (M: AEIS) -1.08 -0.72 -1.30 -5,320.0 7 0 7 0.21 -57.9 power conversion prods
MKS Instruments (M: MKSI) -0.89 -0.65 -1.35 -3,760.9 5 0 6 0.16 -74.9 measures mfr perform
Cooper Tire & Rubber (N: CTB) -0.21 1.07 -1.05 -2,525.0 6 0 4 0.66 -11.7 mfr car & truck tires
ArvinMeritor, Inc. (N: ARM) -1.64 -1.05 -2.00 -2,202.6 6 0 6 -0.22 -136.2 truck mfr components
Integra Bank Corp. (M: IBNK) -1.35 -0.43 -2.39 -1,246.0 5 0 5 -0.26 -159.1 bank holding co
Entropic Commun (M: ENTR) -0.21 -0.14 -0.28 -895.2 7 0 7 -0.01 -107.4 semiconductors 
Spectranetics Corp. (M: SPNC) -0.09 0.13 -0.28 -825.0 11 0 10 0.03 -78.2 medical devices
Office Depot (N: ODP) -0.47 -0.14 -0.66 -514.2 15 0 14 -0.25 -163.2 office prods and servs
iStar Financial (N: SFI) -3.12 -1.66 -5.47 -450.3 5 0 5 0.45 -63.0 real estate finance co
Applied Materials (M: AMAT) -0.22 0.11 -0.42 -355.8 21 0 25 0.27 -49.7 tech prods for mfrs
                     

Currently, the market appears to have higher expectations for those companies with upward earnings revisions, as indicated by the price-earnings ratios in Table 1. The stocks with 5% or higher upward revisions have a median price-earnings multiple of 19.0, compared to 9.8 for the typical exchange-listed stock.

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In contrast, the 30 stocks with the largest percentage downward revisions have a median price-earnings multiple of 6.1. This pattern holds true as well for the price-to-book-value ratio.

Interestingly, the companies with the largest percentage downward earnings revisions have higher historical earnings growth rates. Stocks experiencing the largest percentage downward revisions over the last month have a median five-year average earnings per share growth rate of 13.8%, compared to 6.5% for the typical exchange-listed stock and compared to –4.8% for stocks with 5% or greater upward earnings revisions. However, the upward revisions firms have median future estimated earnings growth that exceeds both the typical exchange-listed stock and those firms with downward earnings revisions.

Reflecting the strong price performance we discussed earlier, the stocks with 5% or greater upward earnings revisions have outperformed the S&P 500 on a median relative basis by 68% over the last 52 weeks.

In the currently hostile market environment, many individuals and institutions are looking for stocks that offer the greatest degree of safety. Upward earnings revisions in such an anemic economic environment may be an indication of such safety.

In addition, this screen may be isolating stocks that have been particularly bloodied during this market downturn, and rising earnings estimates may be attracting value investors who are, in turn, moving prices upward. Our screens select stocks with upward revisions after the revisions and subsequent initial price increase, and select stocks with downward revisions that may initially have caused them to underperform the market.

The earnings estimate revisions screens produce some of the highest turnover among the screens tracked by AAII. Since the beginning of 1998, between 89% and 93% of the stocks passing one of these screens in one month failed to pass the same screen the next month. This is due to the nature, and frequency, of analyst earnings revisions, which do not occur at regular intervals.

Among the stocks in Table 2, RADVISION LTD. RVSN has seen its consensus earnings estimate for the current fiscal year jump almost 930% over the last month from an expected loss of $0.028 per share to expected positive earnings per share of $0.232. On February 5, the company issued first-quarter earnings guidance of $0.05 per share, which exceeded the consensus estimate at the time of a $0.07 per share loss. Based on this guidance, analysts probably adjusted their full-year estimate models, thereby boosting RADVISION’s consensus earnings estimate.

On the opposite end of the spectrum, Advanced Energy Industries AEIS has seen its current-year consensus earnings estimate plummet 5,320% from an estimated loss of $0.02 per share to a $1.08 per share loss. When the company announced its fiscal-2008 earnings on February 23, it also provided first-quarter 2009 guidance of a loss of between $0.46 and $0.53 per share, compared to the consensus at the time of a $0.10 per share loss. The steep decline in the 2009 consensus most likely reflects this new guidance.

It is also perhaps worth noting that several of the companies with the largest downward earnings revisions had positive earnings for their last full fiscal year, or had earnings that went negative for the first time in several years. In the current economic environment, analysts may be finding it difficult to gauge the downturn’s impact on current fiscal-year earnings for these companies. Once analysts get a clearer picture, either through a quarterly earnings announcement or company earnings guidance, they are responding with significant downward revisions.

Conclusion

While the results of the upward earnings revision screens have shown promising results over the last several years, it is important to note that these screens are only “first-cut” screens. They do not explore issues such as financial strength or liquidity. Instead, they highlight the importance of changes in expectations and their impact on stock prices and the potential benefit of adding an earnings revision consideration to a more robust set of filters.

What It Takes: Earnings Revision Screens Criteria

Upward Revision Screen:

  • There are at least four analysts providing earnings estimates for the current fiscal year
  • The latest earnings per share estimates for the current and next fiscal year are greater than one month ago
  • There has been at least one upward revision of earnings estimates for the current fiscal year as well as the next fiscal year over the last month
  • There have been no downward revisions of earnings estimates for the current or next fiscal year over the last month
  • Only those 30 companies with the highest percentage increase over the last month in the consensus estimate for the current fiscal year are used for performance calculations

These criteria are simply reversed for the downward revision screen.

5% Upward Revision Screen:

  • There are at least four analysts providing earnings estimates for the current fiscal year
  • The latest earnings per share estimates for the current and next fiscal year are greater than one month ago
  • There has been at least one upward revision of earnings estimates for the current fiscal year as well as the next fiscal year over the last month
  • There have been no downward revisions of earnings estimates for the current or next fiscal year over the last month
  • The percentage increase of earnings estimates for the current fiscal year as well as the next fiscal year over the last month is greater than or equal to 5%

These criteria are simply reversed for the 5% downward revision screen.

Wayne A. Thorp, CFA is a vice president and senior financial analyst at AAII and editor of Computerized Investing. Follow him on Twitter at @WayneTAAII.


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