Spoiled By Profit Surprises

6/6/2016


Companies are topping consensus profit estimates so frequently that it no longer seems like much of a surprise. For the first quarter, 73% of S&P 500 Index companies surpassed consensus profit estimates, according to Thomson Reuters, with 99% of the index having posted results. That compares to an average beat rate of 68% over the past four quarters and 63% since 1994.

So far, 26 stocks we recommended at the start of the first quarter have declared earnings, with 73% beating their profit estimates. Our stocks averaged 20% per-share-profit growth for the quarter, while the index is projected to report a 5% decline.

A successful quarter hinges on more than topping profit estimates. Sales, cash flow, guidance, and comments from management also matter. But per-share earnings tend to be the first metric investors check. And given executives' general success in managing analyst expectations, profit misses are often the real surprise — and a catastrophic shock for the stock.

Avoiding all negative surprises all the time is virtually impossible — they're called surprises for a reason — and some cannot be predicted. But we look at several indicators to try to reduce the likelihood of holding a stock that puts up a truly bad quarter.

• Somewhat obviously, we try to focus on stocks that regularly beat estimates. Although a majority of stocks exceed consensus estimates, few do so consistently — just 35% of S&P 500 stocks have topped profit estimates in four consecutive quarters.

• We look at the direction of analyst estimates. This trend has value in part because analysts most on top of a stock will tweak estimates to reflect changing conditions. Natural herding behavior precipitates other analysts to follow suit, causing the consensus to drift higher or lower.

• We check Quadrix, specifically the Earnings Estimates category score. For this story, we also looked at two especially helpful individual Quadrix factors:

1) The Earnings Predictability score measures the variability of a company's profits, relying on the rationale that steady profit trends suggest a company can weather abrupt shifts in the economy.

2) Spread of EPS estimates measures the deviation between the highest analyst estimate for earnings per share and the lowest estimate. A tight range signals general agreement about a company's prospects, increasing our confidence in the consensus.

Based on this criteria, how do our stocks stack up? Of our 29 recommendations, 12 earn above-average Earnings Estimates scores. From among that group, shown in the table below, eight have topped consensus profit estimate in at least seven of the past 10 quarters — and two stocks have beaten estimates in 10 consecutive quarters. In the past 90 days, nine of the stocks have seen their consensus estimates rise; only CVS Health ($97; CVS) and J.P. Morgan Chase ($66; JPM) have suffered from deterioration of the consensus. Finally, just a handful of stocks in this group score well for spread of earnings estimates, but most look attractive based on earnings predictability.

BUILDING CONFIDENCE IN EPS ESTIMATES
We screened for recommended stocks with above-average Quadrix scores for Earnings Estimates. Among that group, we show whether companies were able to manage expectations in recent quarters, as well as trends for analyst estimates. We also checked two key Quadrix factor scores. Spread of high to low EPS estimates rewards stocks with a narrow range, signaling analysts mostly agree about future profits. Earnings predictability identifies companies that generate profit growth with low variability.
Number
Of EPS
Beats,
Past 10
Quarters
---- Current Fiscal Year ----
Est.
EPS
Growth
(%)
----- Est. EPS -----
------------- Quadrix Scores -------------
Company
(Price; Ticker)
Current
($)
90 Days
Ago
($)
Spread
Of EPS
Ests.
Earnings
Predict-
ability
Earns.
Ests.
Overall
Biogen
($287; BIIB)
8
11
18.93
18.65
39
97
65
92
CBRE ($30; CBG)
9
13
2.31
2.26
43
98
69
83
CDW ($43; CDW)
7
11
3.27
3.27
49
NA
64
91
Centene
($63; CNC)
9
38
4.19
3.77
59
73
67
96
Citrix Systems
($86; CTXS)
10
15
4.98
4.71
42
73
81
95
CVS Health
($97; CVS)
6
13
5.82
5.83
77
99
70
80
F5 Networks
($109; FFIV)
5
7
7.11
6.98
57
97
76
95
J.P. Morgan
($66; JPM)
6
(5)
5.68
5.74
39
64
53
74
Lear ($117; LEA)
10
17
12.69
12.04
18
81
93
99
LKQ ($33; LKQ)
6
27
1.81
1.65
69
99
93
92
Nvidia
($47; NVDA)
9
22
2.03
1.81
32
55
98
78
Shire
($191; SHPG)
8
9
12.76
12.68
54
96
83
77
Notes: Fiscal year ends in January for Nvidia and September for F5 Networks.  Quadrix scores are percentile ranks.  NA not available.

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