By Michael Vodicka
There is nothing more important to a stock than earnings. That makes earnings season the most important time of the year for the S&P 500.
The companies that miss expectations will be punished while those that deliver big surprises will be rewarded. But with the economy showing signs of weakness in the past month, analysts aren't expecting a blowout earnings season.
Earnings in the private sector have been trending higher for years, aggressively rebounding out of the financial crisis in 2009. But four years down the line, earnings growth is at the top of a multi-year cycle. Companies have cut all the fat they can cut. Earnings growth needs to come from sales growth, and that has become increasingly difficult with weakness in GDP (gross domestic product).
But there is an upside to these tempered expectations. With early results mixed and analysts' expectations lowered, it's going to be easier to impress the Street with a big surprise. Companies that deliver big earnings surprises will be rewarded.
According to research by financial economists, the post-earnings drift is the tendency for a stock's cumulative abnormal return to drift in the direction of an earnings surprise for several weeks, and sometimes months, following an earnings announcement.
That means an earnings surprise is twice as valuable: a sharp jump in the short run and a tendency to drift higher in the weeks and months to come. Companies that deliver earnings surprises are good for investors.
The seven stocks listed below have seen the largest upward revisions in estimates in the S&P 500 going into first-quarter earnings season. That makes them great candidates for big earnings surprises. These are the kind of big gains my colleague Elliott Gue features in his Top 10 Stocks newsletter.
This may seem like a crazy pick considering Netflix is up a market-crushing 74% on the year. But Netflix has been making big adjustments to its business model, adjustments that many investors are confident will produce big results. That sentiment is being driven by Netflix's entry into the more lucrative, higher-margin content business, inking an exclusive deal with Disney and its subsidiaries and producing original content.
This reversal has already had a stunning effect on earnings projections. Ninety days ago, analysts were calling for 2013 earnings of 44 cents per share. Today, they are projecting earnings of $1.19. Their estimate for next year is even more bullish, pegged at $2.71, another 127% increase in earnings. Netflix is still expensive at this level, trading with a forward price-to-earnings (P/E) ratio of 145. But this stock has clear upward momentum.
It's very rare to see estimates for a large company like Boeing fluctuate 23% in 90 days, but that's exactly what has happened to the aerospace giant's 2013 estimate in the past three months, jumping from $5.20 to $6.37. Those upward revisions are being driven by a number of Boeing's initiatives, particularly the Dreamliner. The Dreamliner entered the market years late and recently endured a damaging battery recall, but investors remain confident the airliner will be a big moneymaker for Boeing.
Analysts are looking for earnings growth of 14% in 2014 and a five-year growth rate of 11%. Boeing is up 15% on the year, but with a forward P/E ratio of 14 -- which is well below its 10-year average of 18 and in line with the S&P 500 -- its shares don't look overvalued. And with a dividend yield of 2.3%, Boeing is a shareholder-friendly company.
Risks to Consider: Although valuation still looks good, some of those higher expectations on rising estimates could already be priced into shares.
These are the seven stocks with the largest upward revisions in estimates going into first-quarter earnings. That is a very bullish signal, given analysts aren't overly optimistic and some early results have been disappointing, making these stocks great candidates to deliver big earning surprises. From the group, my two top picks are Netflix because of its incredible upward momentum and Boeing because of its valuation and dividend.