There are few things that can send a stock soaring like a positive earnings surprise.
When a company exceeds expectations, it sends a powerful message to the street that business is booming — or at least improving.
High, positive earnings surprises can have a dramatic effect on share price.
This effect is on display now, as third-quarter earnings season wraps up.
Amazon (Nasdaq: AMZN) delivered one of the best reports of the quarter, with earnings of $0.52 per share blowing past expectations of $0.01.
The news sent shares of Amazon soaring 13% in one day, adding a mind-boggling $66 billion to Amazon’s market cap in less than 24 hours.
One way to profit from a positive earnings surprise is to predict which companies will beat the Street before it happens.
As you can see in the case of Amazon, this can be very profitable. However, it’s also a tricky move to pull off. It’s difficult to predict which companies will beat expectations. After all, you’re going up against the predictions of the world’s most successful and well-informed investment institutions.
Even if you’re right, it’s also difficult to predict how the Street will react to a report. But don’t worry, I have a better way to profit from a positive earnings surprise.
Not only is it less risky than predicting which companies will beat expectations, but it can also be more profitable. I like to call it one of Wall Street’s best kept secrets.
How I Know Which Stocks Will Keep Going Up
The Post-Earnings-Announcement Drift (PEAD) is one of Wall Street’s best-kept secrets.
It is the tendency for a stock’s cumulative abnormal returns to drift in the direction of an earnings surprise for several weeks (or even several months) following an earnings announcement. Take a look at the chart of return distributions below.
This study demonstrates that companies beating earnings tend to outperform the S&P 500 in the weeks and months following a positive earnings surprise.
Even better, this is the perfect time to profit from the PEAD. Third-quarter earnings season was a smash hit. According to data from Zacks Investment Research, earnings are up 7.6% from last year on 7.2% revenue growth. That helped 73% of S&P 500 companies beat earnings expectations.
Based on the PEAD, I am expecting many of those stocks to outperform the S&P 500 over the next few weeks and months. From that group, here are 7 positive earnings surprises that should benefit the most from the PEAD.
From the list, I have chosen to highlight Amazon and Apple because of their projected earnings growth in 2018.
Amazon delivered one of the best earnings surprises of the third quarter and saw an immediate price jump. That’s great for current shareholders. But the PEAD also tells me that Amazon has a high probability of outperforming the S&P 500 in the next few months. Amazon shares should also get plenty of support from earnings, which are expected to grow 92% in 2018 and hit a new all-time high.
Apple (Nasdaq: AAPL) kept up its winning tradition with another great quarter. Earnings of $2.07 beat expectations by 11%. That nice surprise should fuel shares of Apple for the next few months, potentially to a new all-time high.
Looking forward, I am expecting more good news from Apple. The company has a history of positive surprises, beating expectations in each of the last four quarters by an average of 6.4%. With anticipation of the iPhone X building ahead of the holidays, analysts are expecting outsized earnings growth of 21% in 2018. That could make Apple the first $1 trillion company on the Nasdaq.
Risks To Consider: Beating earnings estimates can increase expectations and make it harder to impress the Street in future quarters. Stocks with a history of beating earnings estimates can also fall sharply if they miss expectations.
Action To Take: These seven stocks delivered some of the best third-quarter results in the S&P 500. According to history, this tells me they should outperform the index in the next six to twelve weeks. Buy any of these seven stocks right now, hold for the next six months and look to beat the market.
— Michael Vodicka
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Source: Street Authority