Years ago, I studied stock analysis under Dr. Len Zacks, an MIT graduate who founded Zacks Investment Research. His Ph.D. thesis detailed what was discovered to be the most powerful influence on forward, near-term price movement: the upward revision of earnings estimates.
Sometimes the company itself makes these revisions, and sometimes analysts covering the company make them. Either way, more than anything else analysts use to evaluate share price — P/E ratios, sales growth, return on equity, etc. — earnings estimate revisions are the most impactful.
In fact, he’s built an entire cottage industry around it.
I’ll tell my Extreme Tech Profits subscribers more about this proprietary “Zacks Rank” system in future issues, because it is a key element in my stock-selection process.
But for today, let’s zoom in on this one factor: the upward EPS estimate revision.
Today I’m going to build a simple scan that features only one filter: % Change in Q(1) EPS Estimates over 4 Weeks > 10%.
I’m going to apply this filter to the S&P 500, also using the S&P 500 as my benchmark index. In other words, I’m telling my scan that out of all the stocks in the S&P — i.e., the 500 largest publicly traded companies — I want to buy only those which, at some point in the past four weeks, have raised their earnings guidance for the forthcoming quarter by over 10%. While that is a tall order, in most weeks there are 10 to 20 companies that satisfy that one requirement.
How does this one filter perform? Very well, indeed. I ran a 5-year backtest (9/6/2013 to 9/7/2018) rebalancing the portfolio every four weeks. These were the results:
As you can see from the chart above, the S&P 500, represented by the red line, has had a pretty good 5-year stretch. It has returned over 90% in that period, turning every $10,000 invested into over $19,000. But by buying only those stocks that have raised their next quarter’s earnings guidance more than 10% in the past four weeks, we’ve doubled that return. Our simple scan returned 180%, turning every $10,000 into over $28,000!
When we break down the stats of those returns, something else stands out. While our scanned stocks did experience a higher degree of drawdown for the period relative to the S&P (-13.2% vs. -9.0%), this 47% increase in downside risk was more than offset by the nearly 100% increase in profit potential. Given, too, that we were trading only about 15 stocks on average, vs. the 500 stocks of the full index, it is no surprise that our system saw more volatility.
So here are the stocks that passed my simple scan filters. There were only three passing stocks (well below the average), which suggests we may be in a period where analysts are a fair bit more cautious than usual about the earnings prospects of large-cap stocks over the coming quarter.
1. HES Corporation (NYSE: HES)
2. Nisource, Inc. (NYSE: NI)
3. Broadcom, Inc. (Nasdaq: AVGO)
Of these three stocks, my favorite for the near-term is Broadcom, Inc. (Nasdaq: AVGO), a cash-strong company that falls under both the cloud computing and Internet of Things subcategories that we focus on in Extreme Tech Profits.
Shares of AVGO are trading at a low peer-relative PE of 25x earnings and a PEG ratio of only 1.75, bolstered by super-strong earnings growth this year in the neighborhood of 200%. This super-efficient semiconductor maker sports massive margins, in part because they own all the means of production, and in part because they serve both Google (Nasdaq: GOOGL) and Amazon (Nasdaq: AMZN), who can afford higher prices.
While these three stocks are certainly worth further investigation, they should not be considered “buys” on their own. Nor are they official picks for my Extreme Tech Profits portfolio (that’s reserved for my subscribers, of course). But you should feel free to research these name on your own — after all, my experience suggests these could be winners.
— Thomas Carr
Cash In On The New Tech Revolution [sponsor]
Last year, the technology sector offered the highest returns of all ranked market sectors, a whopping 34.3% versus 21.8% for the S&P 500. That makes tech the leading sector in six of those years, and it holds the highest average annual sector return (13.1%) for the period, putting investors over 500 basis points — each and every year — ahead of the S&P 500.
But in truth, the real story for tech has yet to be written.
In fact, it is not a stretch to imagine that in years to come, the only sector worth investing in will be technology.
If you’d like to learn more about how we’re targeting the areas of artificial intelligence, cybersecurity, the cloud, the internet of things, robotics and more for MAJOR profits in the months to come, then you should definitely check out this brief transcript while it’s still available.
Source: Street Authority