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To create the list below we started by looking for stocks with a history of surprising the market with positive earnings reports, with an average earnings surprise of at least 5% over the last five quarterly reports.

We continued our analysis by looking at the financial statements of all companies to pick those with encouraging inventory trends.

Specifically, we screened for stocks with strong sales trends by comparing growth in revenue to growth in inventory over the last year. We screened for stocks with positive sales trends, with faster growth in revenue than inventory over the last year. Since inventory represents the portion of goods not yet sold, faster growth in revenue than inventory is considered an encouraging sign.

Finally, we screened for those with bullish sentiment from institutional investors, with significant net institutional purchases over the last quarter representing at least 5% of share float. This indicates that institutional investors such as hedge fund managers and mutual fund managers expect these names to outperform into the future.

The List

For an interactive version of this chart, click on the image below. Analyst ratings sourced from Zacks Investment Research.

Do you think these stocks will outperform like hedge funds expect? Use this list as a starting point for your own analysis.

1. Conns Inc. (NASDAQ:CONN): Operates as a specialty retailer of home appliances, consumer electronics, home office equipment, lawn and garden products, mattresses, and furniture in the United States.

  • Market cap at $1.24B, most recent closing price at $36.21.
  • In Jan 2012: Reported EPS at 0.34 vs. estimate at 0.29 (surprise of 17.2%). In Apr 2012: Reported EPS at 0.35 vs. estimate at 0.33 (surprise of 6.1%). In Jul 2012: Reported EPS at 0.36 vs. estimate at 0.35 (surprise of 2.9%). In Oct 2012: Reported 0.38 vs. estimate at 0.28 (surprise of 35.7%. [Average earnings surprise at 15.48%].
  • Net institutional purchases in the current quarter at 7.2M shares, which represents about 27.31% of the company's float of 26.36M shares. The 2 top holders of the stock are FMR, LLC., and Dimensional Fund Advisors.
  • Revenue grew by 10.6% during the most recent quarter ($206.4M vs. $186.62M y/y). Inventory grew by -20.22% during the same time period ($77.15M vs. $96.7M y/y). Inventory, as a percentage of current assets, decreased from 20.52% to 15.69% during the most recent quarter (comparing 3 months ending 2012-10-31 to 3 months ending 2011-10-31).
  • CONN has a higher than average projected earnings growth rate over the next 5 years (15.0%). This is higher than the likes of hhgregg, Inc. (projected EPS growth over next 5 years at 8.67%) and Best Buy Co. Inc. (projected EPS growth over next 5 years at -3.36%).

2. Carter's, Inc. (NYSE:CRI): Designs, sources, and markets branded children's wear.

  • Market cap at $3.41B, most recent closing price at $57.96.
  • In Mar 2012: Reported EPS at 0.56 vs. estimate at 0.43 (surprise of 30.2%). In Jun 2012: Reported EPS at 0.37 vs. estimate at 0.3 (surprise of 23.3%). In Sep 2012: Reported EPS at 1.02 vs. estimate at 0.89 (surprise of 14.6%). In Dec 2012: Reported 0.89 vs. estimate at 0.84 (surprise of 6%. [Average earnings surprise at 18.53%].
  • Net institutional purchases in the current quarter at 3.9M shares, which represents about 8.13% of the company's float of 47.98M shares. The 2 top holders of the stock are Berkshire Partners, and Viking Global Investors.
  • Revenue grew by 13.62% during the most recent quarter ($689.25M vs. $606.63M y/y). Inventory grew by 0.67% during the same time period ($349.53M vs. $347.21M y/y). Inventory, as a percentage of current assets, decreased from 44.39% to 36.5% during the most recent quarter (comparing 13 weeks ending 2012-12-29 to 13 weeks ending 2011-12-31).
  • Based on conventional valuation ratios, Carter's looks cheap relative to competitors. The stock's PEG ratio stands at 1.49, while its Price/Cash ratio stands at 9. Even on a Price to Free Cash Flow basis the stock looks cheap, with a ratio of 17.62, compared to Ralph Lauren Corporation (P/FCF ratio at 28.03) and Lululemon Athletica Inc. (P/FCF ratio at 39.67).

3. Cynosure, Inc. (NASDAQ:CYNO): Develops, manufactures, and markets aesthetic treatment systems to the dermatology, plastic surgery, and general medical markets.

  • Market cap at $420.29M, most recent closing price at $25.52.
  • In Mar 2012: Reported EPS at 0.06 vs. estimate at -0.01 (surprise of 700%). In Jun 2012: Reported EPS at 0.2 vs. estimate at 0.1 (surprise of 100%). In Sep 2012: Reported EPS at 0.25 vs. estimate at 0.12 (surprise of 108.3%). In Dec 2012: Reported 0.27 vs. estimate at 0.23 (surprise of 17.4%. [Average earnings surprise at 231.42%].
  • Net institutional purchases in the current quarter at 4.2M shares, which represents about 29.85% of the company's float of 14.07M shares. The 2 top holders of the stock are Next Century Growth Investors LLC., and T. Rowe Price Associates.
  • Revenue grew by 25.13% during the most recent quarter ($42.67M vs. $34.1M y/y). Inventory grew by 11.3% during the same time period ($32.91M vs. $29.57M y/y). Inventory, as a percentage of current assets, decreased from 26.11% to 17.94% during the most recent quarter (comparing 3 months ending 2012-12-31 to 3 months ending 2011-12-31).
  • The company has reported strong earnings growth over the last year, with EPS growing by 444.30%, higher than competitors like Abbott Laboratories (EPS growth over the last year at 24.17%) and Medtronic, Inc. (EPS growth over the last year at 14.08%).

4. Fusion-io, Inc. (NYSE:FIO): Focuses on the development, marketing, and sale of storage memory platforms for data decentralization.

  • Market cap at $1.63B, most recent closing price at $16.41.
  • In Mar 2012: Reported EPS at 0.06 vs. estimate at 0.02 (surprise of 200%). In Jun 2012: Reported EPS at 0.09 vs. estimate at 0.04 (surprise of 125%). In Sep 2012: Reported EPS at 0.14 vs. estimate at 0.07 (surprise of 100%). In Dec 2012: Reported 0.13 vs. estimate at 0.08 (surprise of 62.5%. [Average earnings surprise at 121.88%].
  • Net institutional purchases in the current quarter at 6.2M shares, which represents about 7.2% of the company's float of 86.10M shares. The 2 top holders of the stock are FMR, LLC., and NEA Management Company.
  • Revenue grew by 43.31% during the most recent quarter ($120.57M vs. $84.13M y/y). Inventory grew by 14.19% during the same time period ($74.19M vs. $64.97M y/y). Inventory, as a percentage of current assets, decreased from 16.09% to 14.6% during the most recent quarter (comparing 3 months ending 2012-12-31 to 3 months ending 2011-12-31).
  • One reason the company may be reporting earning surprises is because the company's earnings growth looks very weak, with EPS growing by -208.78% over the last year. This is considerably weaker than competitors like Seagate Technology PLC (EPS growth over the last year at 493.10%) and EMC Corporation (EPS growth over the last year at 12.20%).

*Price and EPS data sourced from Yahoo! Finance, Institutional data from Fidelity, all other data sourced from Finviz.

Source: Funds Are Buying 4 Stocks With A History Of Earnings Surprises And Strong Inventory Trends