Stocks That Jump Tend To Keep Moving

3/24/2014


Some phenomena cannot be explained.

Consider the tendency of stocks that exceed quarterly profit expectations to outperform. Numerous studies have shown strategies involving the purchase of stocks that surprised to the upside can yield market-beating results.

Theoretically, such a tactic shouldn't work. The efficient market hypothesis — a cornerstone of modern portfolio theory — holds that the stock market prices companies based on all relevant information, suggesting investors can't beat the market via stock selection or timing strategies.

At this point, you might ask, "If markets are so efficient, how do newsletters like the Forecasts outperform over time?" Such questions have baffled investors for generations. 

The stock market is pretty efficient, probably more so today than it was decades ago, when information trickled through the investment community rather than flowed. However, plenty of investors generate market-beating returns by exploiting mispricings.

A study published in the May/June 2012 issue of Financial Analysts Journal put a different spin on signals from company earnings. Researchers from Cleveland State University and Fudan University in Shanghai found that when a stock moved substantially around an earnings report, suggesting unusually good or bad news previously unobserved by investors, its share price tended to drift in the same direction as the initial move over the next three months.

The study considered the returns of U.S.-traded stocks between October 1971 and December 2009. These researchers didn't look at overall returns in the wake of an earnings declaration — a topic well-covered by past studies — but instead focused on large one-day jumps during the three-day period bracketing an earnings release.

On average, 4% of stocks in the study posted meaningfully positive jumps around a given quarter's earnings announcement. Such companies averaged 90-day returns nearly 5.7% higher than the average stock. Researchers couldn't explain why, but the data were compelling. Stocks with positive price jumps outperformed throughout the market. The strategy worked better for growth stocks than value stocks, but performed admirably for both. It also worked better for smaller stocks than large-caps but delivered strong outperformance across the size spectrum.

These returns are quite volatile, and in real life, no investor should buy or sell a stock simply because it made a big move around its earnings release. However, the trend is impressive, so we screened for recommended stocks that delivered unusual price jumps around their earnings releases but also have broad-based fundamental appeal, as measured by Quadrix® Overall scores above 90.

POSITIVE PRICE JUMPERS
------ Returns Relative To S&P 1500 ------
Company (Price; Ticker)
Earnings
Date
Day
Before
Earnings
(%)
Day Of
Earnings
(%)
Day
After
Earnings
(%)
3-Day
Period
(%)
Quadrix
Overall
Score
Dow Chemical ($50; DOW)
1/29/14
(0.7)
4.9
0.2
4.3
95
Foot Locker ($46; FL)
3/7/14
0.7
8.7
(1.1)
8.3
99
Kroger ($44; KR)
3/6/14
3.0
(0.9)
0.9
3.1
92
Macy's ($59; M)
2/25/14
(1.8)
6.1
3.0
7.4
98
Magna Int'l ($97; MGA)
3/3/14
1.9
5.8
1.1
9.0
99
Norfolk Southern ($97; NSC)
1/21/14
(0.6)
4.7
1.7
5.8
92
Quanta Services ($36; PWR)
2/20/14
(0.1)
7.0
0.1
7.0
96
Skyworks ($37; SWKS)
1/16/14
0.1
(1.5)
7.1
5.6
99
Union Pacific ($189; UNP)
1/23/14
0.2
4.2
0.7
5.1
94
Note: Quadrix scores are percentile ranks, with 100 the best.

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