By Zacks Investment Research on July 13, 2009 | More Posts By Zacks Investment Research | Author's Website
Nothing better than waking up to a positive earnings surprise and big profits. Nothing worse than waking up to an earnings miss and heavy losses in your portfolio.
Second-quarter earnings season is now kicking into full gear and there are few things that move a stock faster, up or down, than an earnings announcement. This is especially true now as we are still in the grips of a turbulent market that likes to punish stocks with bad earnings announcements. This leads to devastating losses for those unfortunate shareholders. However, the rare stocks with positive surprises are richly rewarded. Now is the perfect time to align your portfolio to profit in the month ahead.As most of you already know, Zacks Investment Research specializes in the coverage of corporate earnings. And more importantly, how to profit from this information. So, today I’m going to share with you 3 proven strategies to profit from earnings announcements.
(Hint: Be sure to read to the end as the 3rd strategy is by far the most profitable)
Strategy 1: Four Leading Indicators of Positive Earnings Surprises
I figured its best to get the most obvious strategy out of the way first. The 4 leading indicators I refer to are the 4 factors of the Zacks Rank. Before you skip this section, let me share some information with you that you may not have known.
In the mid-1970s, Len Zacks took his mathematical skills to Wall Street, where his job was to discover stock picking strategies that would beat the market. He had a simple theory that was the precursor to what became the Zacks Rank.Len focused his research on finding stocks that were more likely to have a positive earnings surprise and jumping on the news. The journey led him to what we know as the 4 factors of the Zacks Rank. Each individually increases the odds of owning stocks that will enjoy a positive earnings surprise. However, when you combine them together inside the Zacks Rank, it becomes an almost obscene advantage for investors. (Learn more about 4 Factors of the Zacks Rank, in this video.)
Strategy 2: Stop the Bleeding
This second strategy is so simple, yet so hard for most investors to do. So, I’m going to beat it into your head…for your own good of course ;-) Sell All Companies with a Negative Earnings Surprise. Yes, sell it immediately. Even after it falls at the open. Even if it is for a substantial loss. Why? Better to take a 10-20% loss in the short run than a 20 to 40% loss in the long run.
Keep in mind how earnings estimates are created. Both company executives and brokerage analysts are doing their best to create conservative estimates that the company should easily beat. And when they fall short of those watered down estimates then it points to one of two serious problems.
* Industry conditions have deteriorated and thus they missed their forecasts. This problem will most likely not correct itself in the near-term, leading to further disappointment.
* Company leaders are incompetent. Meaning that they are no good at estimating their own earnings. Or that their strategies for growth are ineffective.
Either reason should give you ample cause to abandon the stock now and move on to greener pastures.
Strategy 3: Buy High and Sell Higher - Most Profitable Strategy
I saved the best for last. This strategy has proven to be the most profitable way to harness earnings surprises. This proprietary metric is called the Price Response Indicator, or PRI.The PRI is amazingly accurate at saying which stocks will rise in the days following an earnings announcement and which won’t. Proving the truism “Buy High and Sell Higher.”The scoring system for the PRI correlates the percent earnings surprise and short-term price reaction preceding the announcement. The model scores stocks from A to E with A’s and B’s being the most likely to increase in price in the days following the surprise. These signals are produced by our systems within hours after the company reports earnings.
Stocks that are rated a PRI of A or B certainly had very strong positive earnings surprises. Even more importantly, most of them had declined in price in the days preceding the announcement. This is the key ingredient because it means that the investment community was wrong about the company’s prospects.These stocks will gap up on the news, yet still there are more gains to be made as the good earnings news spreads through the investment community. Our extensive research clearly shows that these stocks will receive extended buying pressure for about 2 weeks after the report. This gives traders ample opportunity to make consistent profits even after the stock has gapped up on the earnings surprise.
How to Profit from PRI
At this time, the daily feed of PRI signals is only made available to our institutional clients. However, the Zacks Surprise Trader service filters down all the PRI signals with additional variables to find the 2% that have historically provided the best returns. From there we hand pick the signals, turning down 5 out of every 6 to provide our subscribers with a phenomenal opportunity to beat the market. How phenomenal? Since inception in May 2006, Surprise Trader has generated a +16.0% return versus a devastating loss of -24.1% for the S&P 500. Just imagine how well it will perform when we finally leave this bear market behind.
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