SKM
The third-quarter calendar-year earnings season has peaked and is coming to an end. Through the close on November 12, 2021, 460 of the S&P 500 index companies have reported their latest results since the beginning of October.
Among the 6,994 publicly traded companies in the A+ Investor database, the 3,235 tracked by at least one analyst have reported during the third calendar quarter through November 12. Of those 3,235 companies reporting, 1,639 (51%) reported earnings that exceeded the mean estimate by at least one standard deviation of all the estimates provided for the company’s quarter (a SUE score of at least 1.0). By comparison, 682 of the companies in the A+ Investor database have reported earnings for the current earnings season that fell short of the consensus estimate by more than one started deviation (SUE score below –1.0).
Out of the 3,235 companies that have reported since the beginning of October, 1,148 (35.5%) have seen analysts boost their mean estimates by at least 5% for the current fiscal quarter or current fiscal year.
As of November 5, more S&P 500 companies were beating their consensus earnings estimates for the third quarter than average and beating earnings estimates by a wider margin than average. According to FactSet, the index was reporting the third-highest year-over-year growth in earnings since the second quarter of 2010. At that time, analysts were also expecting earnings growth of more than 20% for the fourth quarter and earnings growth of more than 40% for the entire year. According to FactSet, these above-average growth rates are due to a combination of higher earnings for 2021 and an easier comparison to weaker earnings in 2020 due to the negative impact of the coronavirus pandemic.
FactSet reported on November 5 that 89% of the companies in the S&P 500 had reported actual results for the third quarter. Of these companies, 81% had reported actual earnings above estimates, which is above the five-year average of 76%. According to FactSet, if 81% is the final percentage for the quarter, it would tie with the second quarter of 2018 for the fourth-highest percentage of S&P 500 companies reporting positive earnings surprises since the firm began tracking this metric in 2008. In aggregate, companies reported earnings that are 10.3% above estimates, which is also above the five-year average of 8.4%.
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 most significant effect of the surprise can be seen immediately, but the impact of the surprise may be felt for as long as a year. The effect 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 who act on the information quicker and thoroughly.
Changes in estimates reflect analyst expectations of future performance changes 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. Conversely, 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 nearly 7,000 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 quarterly earnings surprises and earnings revisions for the current fiscal year over the last month and three months.
Earnings estimates are a critical 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 nearing the end of the current earnings season, we can start to identify companies that have reported strong (or weak) earnings surprises and 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 November 12, 2021, there were 334 stocks out of the universe of 6,993 companies with an estimate revisions grade of A (down from 393 last quarter).
However, this is still a large universe of companies to sift through. So to begin narrowing down the universe even further, I first applied a filter of an A grade for quality. This lowered the number of companies to 68 from 334.
Research from David Dreman and others shows that deep-value companies respond more favorably to significant positive earnings surprises and react less adversely to negative earnings surprises. Therefore, the next filter I apply looks for a value grade of A. This lowered the number of passing companies down to 17.
To round out this set of grade filters, I also required a minimum of C grades for growth and momentum, leaving us with 14 remaining companies.
This table shows the top 10 of the 14 passing companies based on their estimate revisions score.
None of the 14 companies passing the stock grades screens have A grades across all five factors this quarter.
SK Telecom Co. Ltd. (SKM) has the highest estimate revisions score among these 14 companies at 99. SK Telecom has C grades for growth and momentum beyond the requisite A grades for value, estimate revisions and quality.
Encore Wire Corp. (WIRE) is the closest of the 14 to having A grades for all five factors, falling just short with its B growth grade. Clicking on the ticker for Encore Wire 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 Encore Wire’s estimate revisions grade:
Encore Wire has an overall Estimate Revisions Score of 98, 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 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% within two standard deviations and 99.7% 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 Encore Wire’s estimates for its quarter ended September 30, 2021, was $0.095. The two analysts tracking the company were expecting earnings of $2.92 per share. Still, the company ended up reporting earnings of $8.51 per share. Dividing the difference between the estimates and actual earnings ($8.51 – $2.915) by the standard deviation of the estimates ($0.095), we arrive at an extremely statistically significant SUE score of 58.9 for the latest quarter. The SUE score for the quarter ending June 30, 2021, was also highly statistically significant at 31.9.
The consensus earnings estimate for Encore Wire’s current fiscal year ending in December stood at $22.50 per share as of November 12. One month ago, analysts were forecasting earnings for the year of $15.525 per share. Three months ago, the consensus estimate for the year was $19.58 per share. Using these numbers, we arrive at the percentage change over the last month and the previous three months of 44.9% and 14.9%, respectively.
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. Encore Wire’s SUE score for the latest quarter of 58.9 ranks in the 100th percentile among the nearly 7,000 stocks in the A+ Investor stock universe, while the 31.9 SUE score from the previous quarter ranks in the 99th percentile.
The percentage changes in the current year’s consensus estimate over the last month and three months rank in the 98th and 93rd percentiles, respectively. The percentile ranks for the four underlying metrics are then averaged; for Encore Wire, this translates into an Estimate Revisions Score of 98, 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 essential to consider 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.
