Efficient market proponents like to say that the market does a good job of pricing itself and that asset prices reflect all available information. Stock prices generally reflect the market’s consensus of a full array of company, industry, regulatory and economic forces in play at any time. However, the market is also in a constant state of flux and may not always react rationally and instantly to new information.
Stock prices are established through expectations and adjust as those expectations change or are proven wrong. A slight change in projections can have a major impact on stock prices, especially if the multiple or price-earnings (P/E) ratio investors are willing to pay for a given level of earnings also expands or contracts. Stocks with high price-earnings ratios not only have high expectations, they also possess a higher anticipated certainty of realizing their growth. Lower multiples reflect lower perceived prospects as well as greater risk and uncertainty of achieving results.
Consensus estimates are the average of the estimated earnings and sales levels made by analysts who are following specific companies. Widely followed firms such as Amazon.com Inc. (AMZN) have over 40 analysts providing estimates, while smaller firms have just a few analysts following them. Over 460 companies have just one analyst projection. Just over 3,750 companies currently have earnings estimates from the universe of 4,641 exchange-listed companies tracked by I/B/E/S, a reporting service used by AAII.
Having moved through the meat of the earnings season for the latest calendar quarter ended June 30, many companies have seen their stock prices move significantly following their earnings announcements.
This is because the market is forward-looking. Security prices are dictated by expectations, and prices fluctuate as these expectations are affirmed or are proven to be unfounded, and as analysts adjust their expectations based on the company’s latest results and updated management guidance for future quarters.
Stock prices of firms that significantly exceed analyst expectations (positive earnings surprise) tend to outperform the market, while those with negative surprises tend to underperform. This is especially true for low price-earnings ratio stocks, as research from David Dreman and others have shown. For high price-earnings ratio stocks, the impact of a negative earnings surprise can be swift and devastating.
The impact of the earnings surprise is longer lasting than most would think. The greatest effect of the surprise can be seen immediately, but the impact of the surprise can be felt for as long as a year. The impact tends to be longer lasting for negative earnings surprises. It simply takes time for the market to recognize that a fundamental shift is taking place. This means that it does not generally make sense to be a bargain hunter and buy a stock after the initial price decline on a negative earnings surprise. There is a good chance the stock will continue to underperform the market for some time. Separately, it may not be too late to buy into an attractive stock after a better-than-expected earnings report is released, provided the fundamentals are still valid.
Not surprisingly, large firms tend to adjust to surprises faster than small firms. Larger firms are followed by more investors, analysts and portfolio managers acting on the information more quickly and thoroughly.
Changes in estimates reflect changes in analyst expectations of future performance and lead to price adjustments similar to earnings surprises. When earnings estimates are revised significantly upward—by 5% or more—stocks tend to show above-average performance. Similar to earnings surprises, earnings revisions for high and low price-earnings stocks tend to have a greater impact on stock prices. This tends to be the case for upward revisions for low price-earnings stocks and downward revisions for high price-earnings stocks.
Furthermore, changes in analyst estimates are more meaningful when individual estimates move away from the average, rather than toward the consensus.
A+ Investor subscribers have exclusive access to Stock Grades for over 6,000 stocks for factors of value, growth, momentum, quality and estimate revisions. The estimate revisions grade ranks companies by the strength of their recent quarterly earnings surprises and earnings revisions for the current fiscal year over the last month and last three months.
The Stocks page of AAII.com notes if any stocks have consistently high or low grades across the many factors and separately reveals significant changes in their grades.
The “My Stocks” tab of the A+ Stock Grades section shows you the factor grades for all of the stocks you have entered into portfolios you’ve created using the My Portfolio tool:
Clicking the “See All” link will give you the factor grades for all the stocks you hold or track. Seeing these grades can offer confirmation of why you are holding or tracking these stocks or provide an indication that something is changing that requires additional analysis.
The My Upgraded/Downgraded Stocks tab of the A+ Stock Upgrades & Downgrades section lists those stocks you hold or track with My Portfolio that have seen two or more factor grade changes in the same direction over the last trading day:
Once again, clicking the “See All” link will show you all of your stocks that have seen at least two factor grade changes in the same direction over the last trading day.
Earnings estimates are an important element to consider as investors look for stock ideas and manage their holdings.
Using the A+ Stock Grades Screener, you can isolate those companies that grade highly based on earnings estimates (along with growth, value, momentum and quality).
The A+ Stock Grades Screener allows you to filter for stocks with specific factor grades. As of the close on August 14, 2020, there were 243 stocks out of the universe of 6,149 companies with an Estimate Revisions Grade of A:
For companies that have reported their earnings for the current earnings season, the Estimate Revisions Grade reflects not only the latest earnings surprise, but also the earnings surprise for the previous fiscal quarter and the changes to the consensus estimate for the current fiscal year over the last month and the last three months.
Companies tend to see movement in their consensus estimates following an earnings announcement as analysts digest the information revealed from the latest quarter and any revised guidance that management may provide about future quarters and the current fiscal year.
This is still a large universe of companies to sift through. As we mentioned earlier, positive earnings surprises and upward estimate revisions for low price-earnings stocks, all else equal, tend to have a positive impact on shares prices.
To try to capture stocks with low valuations and strong price momentum, which may be attributable to a recent positive earnings surprise or strong estimate revisions, we also applied filters for deep value (A or better) and above-average price momentum (B or better). We lastly applied filters for average or better levels of growth and quality (C or better for both factors) which narrows the number of companies down to 16:
This table is sorted in descending order by momentum.
To dig deeper into the Estimate Revisions Grade for an individual stock, we clicked on MarineMax Inc. (HZO) from the passing company list to get to its Stock Evaluator page. From there, clicking on the Grades tab takes you to a detailed explanation of each of the five factor grades. For this example, we focus on MarineMax’s Estimate Revisions Grade:
MarineMax is a recreational boat and yacht dealer in the U.S. Through more than 50 retail locations throughout the country, the company sells new and used recreational boats, including pleasure and fishing boats. MarineMax also sells related marine products, including engines, trailers, parts and accessories. In addition, it provides repair, maintenance and slip and storage services; arranges related boat financing, insurance and extended service contracts; offers boat and yacht brokerage sales; and operates a yacht charter business.
MarineMax has an overall Estimate Revisions Grade of A. This grade is arrived at by using four different pieces of data:
To say that a company missed or exceeded their quarterly consensus estimate does not necessarily capture the real significance of such an event. There are several ways of measuring the significance of an earnings surprise. One method of measuring the magnitude or significance of earnings surprises is with the standardized unexpected earnings (SUE) score.
SUE measures the earnings surprise in terms of its number of standard deviations above or below the consensus earnings estimate. An earnings surprise is considered more significant the farther it is outside the statistical range of estimates expected at the time of the announcement. Assuming a normal distribution of earnings estimates, 68.3% of actual earnings will be within one standard deviation of the consensus estimate, 95.4% will be within two standard deviations and 99.7% will be within three standard deviations. The absolute value of SUE measures the degree of unexpected earnings. There is no earnings surprise when the SUE score equals zero; the actual earnings per share is in line with the consensus earnings estimate.
On July 23, 2020, MarineMax reported a 119.7% positive earnings surprise for the quarter ended June 30, 2020, and an 18.6% positive earnings surprise on April 23, 2020, for the fiscal quarter ended March 31.
The standard deviation of MarineMax’s estimates for its quarter ended June 30 was $0.092 per share. Given this, along with the difference between MarineMax’s reported earnings for the quarter ($1.58 per share) and the consensus estimate for the quarter of ($0.719 per share) of $0.861 per share, we arrive at a statistically significant SUE score of 9.4. This ranks in the 97th percentile among all U.S.-listed stocks.
For the prior quarter, the dispersion of estimates was significantly smaller ($0.028 per share), but so too was the difference between the actual earnings ($0.23 per share) and the estimate ($0.194 per share) of $0.036 per share. So while the earnings surprise percentage was relatively high at 18.6%, the SUE score for the period was only 1.3. However, this still ranks in the top 26% among all stocks.
The consensus earnings estimate for MarineMax’s current fiscal year ending September 30, 2020, stands at $2.594 per share, and is based on the estimate of eight analysts. A month ago, it was $1.536 per share and three months ago it was $1.016 per share. Using these numbers, we arrive at the percentage change over the last month of 68.9% and over the previous three months of 155.3%. These percentage changes rank in the 95th and 98th percentiles, respectively, among all U.S.-listed stocks.
The percentile rankings for the four metrics used for the Estimate Revisions Grade are then averaged; for MarineMax, that translates into an estimate revisions score of 91, which places it in the A or “very positive” range.
As an aside, MarineMax shares have risen 32.3% over the four-week period ended August 14 and 129.3% over the past year.
While investing in companies seeing significant upward earnings revisions has been shown to generate promising results over the long term, it is important to take into consideration elements of financial strength, quality or price momentum.
As an A+ Investor, not only can you evaluate the estimate revisions of individual stocks, you can use the Stock Grades Screener to isolate those companies with high estimate revisions scores along with elements of growth, momentum, quality and value.
