During the month of April, analysts increased their earnings estimates for companies in the S&P 500 index for the second calendar quarter (running from April 1 through June 30), with the bottom-up earnings estimate for the index increasing 4.2%. According to FactSet, during the typical quarter, analysts usually reduce earnings estimates during the first month of the quarter. Over the last five years (20 quarters), the average decline in the bottom-up earnings estimate for the S&P 500 has been 2.0%. The increase in the earnings estimate for the S&P 500 during the first quarter of this year was the second-highest increase during the first month of a quarter since FactSet started tracking this metric in 2002. It currently trails the first quarter of 2018, when the estimate rose 4.9% during the first month of the quarter.
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 PayPal Holdings Inc. (PYPL) have 40 or more analysts providing estimates, while smaller firms are lucky to have even one analyst following them. More than 4,000 companies in the A+ stock universe have at least one analyst providing an earnings estimate for the current fiscal quarter. Of those, slightly more than 450 have only one analyst estimate. Among the 5,035 exchange-listed companies tracked by I/B/E/S, a reporting service used by AAII, roughly 80% have at least one analyst tracking them (3,967).
When using earnings estimates, the first rule to consider is that the current price generally already reflects the consensus estimate. There is nothing to gain by simply looking for companies with high levels of expected earnings growth. Studies show that over the long run, stocks with high expected earnings growth tend to underperform stocks with lower growth projections. It is difficult to continually meet and exceed high expectations over an extended period—commonly referred to as reversion to the mean. The most profitable earnings estimate strategies focus on surprises and revisions.
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.
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—5% or more—stocks tend to show above-average performance. Stock prices of firms with downward revisions show below-market performance.
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 6,300 stocks for factors of value, growth, momentum, quality and estimate revisions. The estimate revisions grade ranks companies by the statistical strength of their two latest recent quarterly earnings surprises and earnings revisions for the current fiscal year over the last month and three months.
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).
Now that we are into the second month of the current earnings season, we can start to identify companies that have reported strong (or weak) earnings surprises as well as those seeing their consensus estimates revised (upward or downward).
The A+ Stock Grades Screener allows you to filter for stocks with specific factor grades. As of the close on May 7, 2021, there were 322 stocks out of the universe of 6,356 companies with an estimate revisions grade of A.
This is still a large universe of companies to sift through, but applying filters for above-average (B or better) value, growth, momentum and quality to the universe of companies with “A” grades for estimate revisions narrows the number down to 30:
This table shows the top 10 of the 30 passing companies based on their Estimate Revisions score.
This list also shows the only two companies from the 30 that have “A” grades across all five factor grades: Century Communities Inc. (CCS) and MarineMax Inc. (HZO).
Clicking on the ticker for Century Communities takes us to its Stock Evaluator page. From there, clicking on the Grades tab takes us to a detailed explanation of each of the five factor grades. For this example, we focus on Century Communities’ Estimate Revisions Grade:
Century Communities has an overall Estimate Revisions score of 92, which translates into an “A” grade. This grade is arrived at by using four different pieces of data:
To say that a company missed or exceeded its 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, 68.2% 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.
The standard deviation of Century Communities’ estimates for its quarter ended March 31, 2021, was $0.205. Given this, along with the difference between Century’s reported earnings for the quarter of $3.00 per share and the consensus estimate of $1.595, we arrive at a highly statistically significant SUE score of 6.9 for the latest quarter. The SUE score for the quarter ending December 31, 2020, was nearly as statistically significant at 6.3.
The consensus earnings estimate for Century Communities’ current fiscal year ending in December stands at $11.645 as of May 7. One month ago, analysts were forecasting earnings for the year of $8.323. Three months ago, the consensus estimate for the year was $8.520. Using these numbers, we arrive at the percentage change over both the last month of 39.9% and the previous three months of 36.7%.
The “raw” values of the four metrics used for the Estimate Revisions Grade are then converted to percentile ranks, which compare them against all of the stocks in the universe. Century Communities’ SUE score for the latest quarter of 6.9 ranks in the 91st percentile among the 6,300 or so stocks in the universe, while the 6.3 SUE score from the previous quarter also ranks in the 91st percentile. The percentage changes in the current year’s consensus estimate over the last month and three months rank in the 96th and 90th percentiles, respectively. The percentile ranks for the four underlying metrics are then averaged; for Century Communities, that translates into an estimate revisions score of 92, which places it in the A or “very positive” range.
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, but you can also use the Stock Grades Screener to isolate those companies with high estimate revisions scores along with elements of growth, momentum, quality and value.
