As the first quarter earnings season unfolds, investors will stop obsessing about what the Fed’s going to do for some time, and confront the ground reality of the performance of the companies. The first-quarter earnings season is carting along with it a gloomy shroud of declining earnings estimates. While negative estimate revisions have been a recurring theme for several quarters now, the sheer magnitude of this quarter’s revisions is something that the market hasn’t seen since the Great Recession.
Current estimates for the S&P 500 stocks are portending consecutive negative earnings "growth" for the first two quarters of 2015. Two back-to-back quarters of negative growth is what we call an "earnings recession" — something the market hasn't seen in quite some time.
Never-Ending Negative Revisions
Till the very end of 2014, analysts were expecting earnings growth of 4.3% in the first quarter of this year. In a matter of a few months, that projection has slumped to -4.6%. Even more alarming is the markdown in the second-quarter expectations. S&P 500 companies that were expected to deliver earnings growth of 5.3% are now expected to chart negative growth of 1.9%. What’s more, there is still ample amount of time left for more downward revisions, which could potentially push the full-year 2015 growth rate into the negative territory.
For the first quarter, a significant part of the drag comes from the energy sector, as it grapples with relentlessly plunging oil prices. However, almost all sectors are expected to be impacted by a strong dollar, a fragile global economy and the recent flurry of sub-standard data back home. The few sectors that look somewhat buffered are Healthcare, Financials, Utilities and Telecoms.
Sifting out the Winners
There could be another, slightly warped reason for the disappointing estimate revisions as well. Recent trends suggest that management teams have shown a penchant for the art of expectations management — by under-promising and over-delivering. To that end, they consistently provide weak earnings guidance, thus dragging estimates down.
Be that as it may, it is indisputable that there will be plenty of companies that will conquer all odds and emerge as winners this season. Although not all companies that post positive earnings surprises see their stock price appreciate, studies indicate that on an average, earnings beats drive strong returns in share prices for several weeks following the report. This is what we call the post-earnings-announcement drift. Picking out and investing in such stocks before they report earnings can substantially boost your portfolio returns.
The Zacks Advantage
While it is impossible to know with complete conviction which stocks have the potential to beat estimates this earnings season and which ones will disappoint, our proprietary Earnings ESP (Expected Surprise Prediction) system makes it a relatively easy ride.
Earnings ESP – the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate – is our proprietary methodology for distinguishing stocks that have a high chance of beating estimates in their next earnings reports.
A straightforward way to narrow down such stocks is to screen them with a favorable Zacks Rank – Zacks Rank #1 (Strong Buy), #2 (Buy) or #3 (Hold) – and a positive Earnings ESP. The combination of a favorable Zacks Rank and a positive Earnings ESP usually heralds an earnings beat. Our research shows that the chance of a positive earnings surprise for such stocks is as high as 70%.
To refine our screen further, we are considering only those stocks that have an impressive history of beating estimates in the past four quarters. Also, these champions have been seeing positive estimate revisions of late, flying in the face of the general trend.
Our Potential Outperformers
Valero Energy Corporation (NYSE:VLO) (VLO - Analyst Report) is based in San Antonio, TX, and is the largest independent refiner and marketer of petroleum products in the U.S. Valero is also benefiting from the negative correlation of the refining business with crude oil prices.
This Zacks Rank #1 company has an Earnings ESP of +7.36%. The Most Accurate estimate for the company is currently at $1.75, ahead of the Zacks Consensus Estimate, which is pegged at $1.63 for the first quarter.
Furthermore, the company belongs to the Oil Refining & Marketing industry, which presently lies in the top 4% of industries, per the Zacks Industry ranking system.
The company has beaten estimates in each of the last four quarters, registering an average quarterly beat of nearly 24%. With its impressive combination of the top Zacks Rank and a positive earnings ESP, this company looks set to continue its winning streak in the upcoming earnings report.
Mallinckrodt (NYSE:MNK) public limited company (MNK - Analyst Report) is a specialty biopharmaceutical and medical imaging company based in Dublin, Ireland. This Zacks Rank #1 company has an Earnings ESP of +7.90%. The Most Accurate estimate for the company is currently at $1.64, ahead of the Zacks Consensus Estimate, which is pegged at $1.52 for the first quarter.
Additionally, the company belongs to the Medical — Generic Drugs industry, which currently lies in the top 25% of industries, per the Zacks Industry ranking system.
The company has beaten estimates in each of the last four quarters, registering an average quarterly beat of nearly 26%. With its impressive combination of the top Zacks Rank and a positive earnings ESP, this company looks confident of continuing its winning streak in the upcoming earnings report.
Marathon Petroleum Corporation (NYSE:MPC) (MPC - Analyst Report) is engaged in the refining, transportation and marketing of petroleum products, and is the fourth largest refiner in the U.S. Tumbling crude prices are a significant tailwind to this company as it translates to higher refining margins.
This Zacks Rank #1 company has an Earnings ESP of +4.43%. The Most Accurate estimate for the company is currently at $2.83, ahead of the Zacks Consensus Estimate, which is pegged at $2.71 for the first quarter.
Moreover, the company belongs to the Oil Refining & Marketing industry, which at present lies in the top 4% of industries, per the Zacks Industry ranking system.
The company has registered an average quarterly beat of over 24%, and with its impressive combination of the top Zacks Rank and a positive earnings ESP, looks well poised to continue its winning streak in the upcoming earnings report.
A Winning Strategy
The first quarter earnings season is just taking off, and it looks to be capricious at best. Companies are facing crucial headwinds, including some which affect their bottom line directly, like crude oil prices and the U.S. dollar.
However, like always, there will be some companies that will trump these challenges and stand out with great earnings surprises. Employing the Zacks' Earnings ESP system can significantly increase your odds of discovering these winners before they report and riding on the potential stock appreciation that follows.