There are few tools (indicators) that allow you a strong singular edge over the market. Even if they do, they’re often complex, convoluted and are extremely subjective even to use as a guide or starting point.
Rarer still will you find them offered for no cost whatsoever.
But here at Zacks, there is one indicator that can offer you an extremely powerful edge when trading stocks over earnings. When used properly, the Zacks’ ESP (Expected Surprise Prediction) is a simple and effective way to gauge whether a stock will meet, beat or miss earnings; and there are few things that move a stock further or faster than a earnings surprise.
So trading during earnings season can be very profitable if you have the right tools. ENTER Earnings ESP.
Clarity in a Foggy Environment
The stock market seems to be teased and tormented by every little bit of data that flows from just about any direction. Worse still is that when investors try to get honest, objective data they are often loaded up with unnecessary B.S.
The good news is that there are four times a year that we get complete clarity from companies based on fact and informed opinion, earnings. Earnings, while exciting, can be volatile, so you want to be sure you’re on the right side of that volatility.
Making matters worse, earnings and company facts are now clouded by random, in experienced bloggers and reports from sources that I have a hard time trusting. Just about anyone these days can pose as an expert on the net and often I find that those who are good at getting recognized on the web, are not necessarily the best ones to listen to.
If you want to find the truth, look to reputable analysts and with the companies themselves. Analysts may not be traders, but they spend most of their waking hours researching a very small group of companies and often know those companies almost as well as the executives that run them.
Analyzing their behavior is instrumental for gaining real insight and is the foundation of Zacks. The Zacks Rank is an effective means of measuring not only the sentiments of analysts, but taking an amalgam of other data and translating that into a rank number of 1 to 5.
Analysts and the fund managers that work closely with them are what I classify as “Smart Money,” mainly because they have (or control) a ton of it and when they move that war chest around, stock prices tend to follow suit; usually in a big way.
If we can find the most efficient way to get a free look into their next moves and “ride their coattails” into and out of stocks, then you can bet the chances of success are increased immensely.
Beyond the Zacks Rank with ESP
The goal of the Zacks Rank is to effectively follow the earnings trends of companies and in effect the smart money trends. Following the Zacks Rank is one way investors can stay in outperforming trades for longer periods. But as a market maker, I prefer to the quick action; most of my trades in my Whisper Trader Earnings Service are less than 7 days in duration and all take place around earnings, so while I use the Zacks Rank, there’s a special focus on a stock’s ESP indicator, which I’ll show you shortly.
If you are looking for a stock likely to beat, it’s a good idea to start with a Zacks Rank 1 or 2. Rank 3s are acceptable, but I prefer the 1 or 2 for added peace of mind. The Example below of Wells Fargo is just fine at a #2.
It’s also helpful to watch for the Zacks Consensus moving higher into the report as demonstrated in the Magnitude area below. Note how estimates for the current and next quarters are both higher than they were 90 days ago; the same goes for the annual estimates. This is what you want to see to spot the best candidates.
From there I like to drill down to the analysts specifically (preferably high profile or the most accurate ones) who are making relatively dramatic shifts in sentiment or their target just ahead of a report. If the consensus is for $0.18 in EPS (earnings per share) and an analyst ups his EPS expectation from $0.17 to $0.22, that’s a tell tale sign that he might know something or believe so strongly about something that it might be worth further investigation for a buy. We see that below in with Suntrust Robinson Humphrey’s upgrade shown in the “quarterly estimates by analyst” screen.
Double check the agreement of analysts to make sure that the majority of the analysts action has been positive by looking in the agreement area as seen below. Notice the number of upward revisions vs. downward revisions. Think of the screen below as a show of hands for a stock going higher or lower; the higher the “up to down” ratio, especially just ahead of a report, the better.
The ESP
Now that we’ve established a solid fundamental base for the stock, checked on the analysts, let’s look at the ESP and see just what the odds are!
This stock has a positive 29.41% ESP for the coming quarter! As you’ll read below, it doesn’t need to be this high. Anything above 3% tends to work well for me and I like to see current full year ESPs positive for this year and next just to stack one last chip in my favor.
The Accuracy of ESP
Of course, some ESP numbers are better than others. In our testing, over the last 10 years, we have found that stocks with a positive ESP and with a Zacks Rank of 1, 2 or 3 (Strong Buy, Buy or Hold), produced a positive surprise 70% of the time. (The other 9% of the time, they reported in line with expectations, with a negative surprise occurring only 21% of the time.)
ESP Earnings Tests
Size does matter (to some extent anyway) when it comes to ESP. Let’s look at the size of the ESP that has historically generated the best results.
First, just having a positive ESP produces market beating results. Over the last 10 years, using a 1 week holding period (stocks were held for no more than one week after they reported), the average annual return was 23.5%. This is in stark contrast to stocks with a negative ESP which produced a -9.20% return.
Now apply the Zacks Rank of 1, 2 or 3 to that list and the returns jump to 28.3%.
If you require your stocks to have an ESP of greater than 1%, we found it increased performance to 29.6%. An ESP of greater than 2% bumps performance up to 31.6%. While an ESP of greater than 3%, produces an average annual return of 37.2%.
The good news is that there’s no need to hold out for stocks with significantly higher ESP’s than 3%.
While some stocks with higher ESP’s will do fantastic, there’s no aggregate increase in performance by ratcheting it up beyond d the 3% threshold. And as the above stats illustrate, simply having a positive ESP (i.e., the Most Accurate Estimate is above the Consensus) still produces stellar results with a high probability of success.
Moving Forward
Trading earnings with a portion of your portfolio is an excellent way to add diversity to your portfolio. If you’re not trading them, at least get informed about the positions you are in for the long term.
Test your knowledge and check out Dunkin Brands (DNKN) and Ford (F), both of them are viable ESP trades that are reporting earnings in the near future!
Right now, I know that many of you have cash sitting idle which can be at least partially invested in earnings trades from my Whisper service or in trades that you research on your own to help supplement the poor returns in money markets. Learn more about my Whisper Trader portfolio.
In markets that are uncertain like these, it’s beneficial to have analysts and big brokerage houses on your side if you are take a position in a stock. Even better to have a tool that gives you a simple read on just how confident they are in a stock ahead of their report.
Jared A Levy is one of the most highly sought after traders in the world and a former member of three major stock exchanges. That is why you will frequently see him appear on Fox Business, CNBC and Bloomberg providing his timely insights to other investors. He has written and published two tomes, “Your Options Handbook” and “The Bloomberg Visual Guide to Options”. You can discover more of his insights and recommendations through his two portfolio recommendation services:
Zacks Whisper Trader– Learn to buy stocks likely to have robust earnings BEFORE they report.
Zacks TAZR Trader – Technical Analysis + Zacks Rank. Best of both worlds approach to find timely trades.
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