By: Todd Bunton
March 07, 2011
It has been over 30 years since Len Zacks discovered that:
Earnings estimate revisions are the most powerful force influencing stock prices.
While this is a remarkably powerful short-term indicator, long-term investors should take note too.
An Object in Motion Tends to Stay in Motion
This is because companies with rising earnings estimates are likely to beat earnings expectations in the future. That is, companies with strong earnings tend to produce more strong earnings. Companies with weak earnings tend to produce more weak earnings.
This cycle, or earnings momentum, can go on for quite some time. That’s why it is wise to sell companies with negative earnings revisions as soon as possible.
Investors should also consider that earnings forecasts from both company management and brokerage analysts tend to be overly conservative. The main reason for this is that neither analysts nor company executives benefit from overly optimistic earnings forecasts.
This can result in an interesting trend.
Say business at ABC Corp is picking up and the company posts a strong quarterly earnings report, easily beating the consensus earnings estimate. Analysts then raise their earnings forecasts, albeit conservatively, and the stock goes up.
When the next quarter rolls around, the company delivers another strong quarter (earnings momentum), analysts raise their estimates once again (conservatively), and the stock goes up. This can go on and on for several quarters.
Now that’s a trend I'd like to be a part of!
The Price & Consensus Chart
One of the best ways to visualize a company’s earnings momentum is to look at its Price & Consensus chart. This chart plots a stock’s price along with the Zacks Consensus Estimate over time.
You can check it out yourself at Zacks.com. Just plug in the ticker of your desired stock into the ‘Quote’ box. When it loads, select ‘Price & Consensus’ from the drop-down box.
What you're looking for are positive slopes in the consensus earnings estimates over time. This signals strong earnings momentum, which means more upward earnings revisions - and higher stock prices - could be on the horizon.
One interesting item to look for is how consensus estimates moved during the Great Recession of 2008-2009. Some companies will have strong negative slopes in their 2008 and 2009 consensus estimates and strong positive slopes for 2011 and 2012. These are cyclical stocks.
On the other hand, some stocks will have relatively flat consensus estimates over the last few years but also flat estimates for 2011 and 2012. These are more defensive stocks.
If you happen to find a company with relatively stable consensus estimates during the Great Recession and strong positive slopes for 2011 and 2012 estimates, then you've found a rare stock indeed.
Five Amazing Charts
Below are five stocks with strong positive earnings momentum and impressive Price & Consensus charts.
Take a look:
Apple (AAPL - Analyst Report) is a thing of beauty. Not only did consensus estimates hold up relatively well during the Great Recession, the trend for the 2011 and 2012 consensus estimates have been screaming higher since late 2009.
Valuation is attractive too, with the stock sporting a PEG ratio of just 0.97. It is a Zacks #2 Rank (Buy) stock.
Dorman Products (DORM - Snapshot Report) supplies original equipment dealer automotive replacement parts primarily for the automotive aftermarket. The stock, like a lot of stocks in the automotive replacement parts and service industry, held up well during the Great Recession as drivers held onto their vehicles longer.
The company has delivered 8 consecutive positive earnings surprises, and the consensus estimates for 2011 and 2012 have been soaring:
Shares trade at just 12.4x forward earnings, a discount to the industry average of 13.6x. It is a Zacks #1 Rank (Strong Buy) stock.
CARBO Ceramics (CRR - Snapshot Report) is the world's largest producer and supplier of ceramic proppants for use in the hydraulic fracturing of natural gas and oil wells.
While that company description might make your eyes gloss over, its Price & Consensus chart won't:
Shares trade at a lofty 28.5x forward earnings, but its PEG ratio is only 0.81. CRR is a Zacks #1 Rank (Strong Buy) stock.
TAL International Group (TAL - Snapshot Report) leases intermodal freight containers and chassis, which is definitely a cyclical business. Although the 2009 consensus estimate finished below where it started, estimates for 2011 and 2012 started taking off in the spring of 2010 and haven't slowed down.
Shares are trading at just 10.9x forward earnings, a significant discount to the industry average of 17.0x. Its PEG ratio is an attractive 0.87. TAL is a Zacks #1 Rank (Strong Buy) stock.
Polypore International (PPO - Snapshot Report) makes highly specialized polymer-based membranes used in separation filtration processes. Consensus estimates for 2011 and 2012 have been soaring as PPO has delivered an average upside surprise of 68% over the last 4 quarters.
Shares trade at 31.9x forward earnings, a premium to the industry average of 15.3x. It has a PEG ratio of 1.99 which is based on a relatively conservative 16.0% five-year growth rate. If the company continues to crush estimates though, this long-term growth rate could increase and justify the relatively high forward multiple.
PPO is a Zacks #1 Rank (Strong Buy) stock.
Conclusion
Earnings momentum can be a powerful indicator of a stock's future direction. The best way to spot this trend is through the stock's Price & Consensus chart. If you haven't already, add it to your tool bag when researching a stock.
Todd Bunton is the Growth & Income Stock Strategist for Zacks.com.
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