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It is useful to track analyst revisions because positive and negative earnings estimates, that is, when reported earnings are higher or lower than analysts’ expectations, can have long-term effects. It’s an investment strategy. AAII created her four screens confirming earnings forecast revisions. One screen is for confirming upward revisions to annual revenue forecasts. Screens for companies with downward revisions. Screens for companies whose annual revenue estimates increased by at least 5% in the last month. And finally, we screen for companies whose annual revenue estimates have declined by at least 5% in the last month. Mr. AAII stock investor professional Consensus revenue forecasts from LSEG I/B/E/S are included and are used to perform the screening.
This article describes a strategy that focuses on companies whose annual earnings estimates increased by at least 5% in the last month. AAII’s 5% expected revision rate increase has averaged 20.6% annually since the inception of the screening model (1998), compared to his 5.8% increase for the S&P 500 over the same period.
Current trends in earnings forecast revisions
According to LSEG I/B/E/S, earnings and sales growth for S&P 500 companies is expected to slow in 2023, with full-year profits expected to rise 2.4% and full-year sales growth 2.0%. The analyst expects that the earnings growth rate of S&P 500 companies in 2024 will be double-digit growth, with he 12.1%. The energy sector is driving down revenue and growth. Excluding the energy segment, expected full-year earnings growth is close to 5.7% and expected revenue growth is 4.7%.
Impact of unexpected revenue
Expectations play a key role in determining whether stock prices go up or down when actual profits are reported. Investors quickly realize that the market is looking to the future. The price of a security is set by expectations, and prices will fluctuate if those expectations change or are proven wrong.
There are several services that track and analyze expected revenue forecasts. Services like LSEG I/B/E/S and Zacks Investment Research provide consensus earnings estimates by tracking the estimates of thousands of investment analysts. Tracking these expectations and their changes is an important and useful strategy for stock investors.
The first rule to keep in mind when using earnings forecasts is that current prices usually reflect consensus earnings expectations. In many cases, actual profits have increased, but not by as much as the market expected, so stocks that report increased profits over the previous reporting period often see their stock prices fall. It’s common. Earnings surprises occur when a company reports actual earnings that differ from consensus earnings expectations.
Most companies release their financial results about a month after the end of the quarter. During earnings season, business news channels and financial websites provide daily reports on earnings releases. Companies that generate significant revenue windfalls often receive attention.
Positive earnings surprise occurs when actual reported earnings significantly exceed expected earnings per share. A negative earnings surprise occurs when reported earnings per share are significantly lower than earnings expectations. Companies with large positive surprises have above-average stock prices, while companies with negative surprises have below-average stock prices.
Although changes in stock prices due to earnings surprises are felt immediately, surprises can have long-term effects. Research shows that the effects can last up to a year after presentation. This means it doesn’t make sense to buy a stock after its initial price drop due to negative expected earnings. The stock is likely to continue underperforming the market for some time. It also shows that it may not be too late to buy into an attractive company after it releases a better-than-expected earnings report.
Not surprisingly, large companies tend to adapt to unexpected events faster than smaller companies. Larger companies are tracked by more analysts and portfolio managers, and they tend to act quickly. Companies that experience large earnings surprises in their quarterly results often experience earnings surprises in subsequent quarters as well. When a company makes a surprise, it’s often a harbinger of similar surprises to come.
Because both positive and negative surprises have long-term effects, a useful investment strategy is to avoid stocks that are expected to have negative surprises or have had negative surprises. Choosing stocks that provide unexpected gains can be just as profitable, not only before, but also after. There is probably some merit in a strategy of simply selling after a negative windfall and buying after a positive windfall.
Stocks that have been revised upward may outperform.
Revisions to earnings estimates by analysts lead to price adjustments similar to those for earnings surprises. When earnings estimates are revised significantly upward (by 5% or more), stocks tend to outperform the average. A company’s stock price that has been revised downward will have a below-average adjusted performance.
Changes in estimates reflect changes in expectations of future performance. Perhaps the economic outlook is better than previously expected, or perhaps a new product is selling better than expected.
Corrections are often a harbinger of unexpected returns. Estimates typically converge toward a consensus as the reporting period approaches. A flurry of revisions near the reporting period could indicate that analysts are missing the mark and are desperate to improve their estimates.
Companies like to report positive business surprises, so it’s not surprising that many companies try to “manage” expectations slightly downward to create positive surprises. Research shows that, on average, there are more positive surprises than negative surprises each quarter. Interestingly, fiscal year estimates do not tend to exhibit a similar positive surprise bias.
Screening for earnings forecast revisions 5% increase
AAII’s first filter excludes companies with fewer than five estimates in the current fiscal year. This filter helps ensure that the revisions actually reflect changes in the general consensus, rather than changes by her one or two analysts. But requiring stocks to report earnings estimates from at least five analysts would crush most small-cap stocks.
The number of quotes for each company is provided to assess interest in that company and the overall quote meaning. The larger a company, the more analysts will track it. The number of upward revisions shows how many analysts have revised their estimates upward in the last month. A comparison with the number of analysts providing estimates confirms the importance of the rate of change in estimates. If the majority of analysts tracking a company have revised their estimates, we can give you more confidence in the revisions.
The following filter requires that the consensus forecast for a company’s current fiscal year (Y0) and next fiscal year (Y1) has changed upwards over the last month. We also screen to see if analysts have lowered their estimates for the current or next fiscal year in the past month. Naturally, we also look for companies whose revenue estimates for the current and next fiscal year have increased by at least 5% in the last month.
Changes in expectations move stock prices
Earnings estimates are important. These are numerical expressions of expectations, and changes in expectations move stock prices. If you’re investing in individual stocks, it’s worth keeping a few things in mind about earnings forecasts.
- Find out the consensus earnings forecast for stocks you own or are interested in.
- Understand that stock prices already reflect consensus regarding future earnings. Note that if a stock is highly touted, the recommendation should be based on analyst earnings forecasts that significantly exceed the consensus opinion.
- Before investing, ask and carefully evaluate the basis for earnings forecasts that deviate significantly from consensus.
- Big surprises in earnings, whether positive or negative, can have a long-term impact on the stock price, as analysts revise their long-term earnings estimates accordingly.
Stocks that passed the 5% Up Expected Revision Screen (ranked by current year revisions made last month)
American Association of Individual Investors
Want to learn more about this topic? AAII Stock Screening Community Check out this and other conversations about using stock screens.
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Stocks meeting the criteria for this approach do not represent a “recommended” or “buy” list. It is important to do your due diligence.
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