I wasn’t always a good investor. Over the past 30 years I’ve made just about every mistake imaginable.
- Jumped in at the peak.
- Jumped out too late.
- Bought falling knives.
- Doubled down on losers.
- You name it, I probably did it.
By the time I joined up with Zacks Investment Research in August 1999, I had eradicated most of those bad habits. But as Len Zacks and his brother Ben pointed out ... I had a lot to learn.
What they taught me is that, indeed, earnings estimate revisions (EER) are the most powerful force impacting stock prices. And nothing captures that power more than the Zacks Rank rating system, which has proven its long term performance.
The timing of this profound investment message could not have been better for me. As the stock market bubble popped in 2000 I started to apply this new investing approach. So even though the market tumbled that year I actually gained +16% in my personal account.
Was I hooked? Heck yes!
Each year since my knowledge and passion for this approach has grown. And there is nothing I like more than to share the wisdom of this investing strategy with others. My goal today is to spread some of that wisdom on to you so you can also enjoy great investment success in the years to come. I’m going to do that by listing.
Three Reasons to Use Earnings Estimate Revisions to Pick Better Stocks
1) The Most Fundamentally Sound Metric: There are so many different websites, magazines, books, TV stations etc. dedicated to investments. The amount of information overload is so unbearable that most investors walk away horribly confused about what is truly important to achieve success. So let me simplify the matter for you so you can push away all that noise and nonsense in the future.
At the end of the day, all stock price movements can be traced back to earnings.
Read that line again so it really sinks in. The reason it’s true is from the basic fact that when you buy shares in a company, you are actually buying a percentage ownership stake in that firm. And if you are the owner of a company, big or small, then the single most important metric to gauge success is how much earnings are generated.
If profits go higher than expected, the share price will rise. Conversely if profits go lower than expected, the share price will come down as well. The stock market has always worked on this premise and it always will. And nothing captures the essence of this notion more than earnings estimate revisions.
2) Applies to Every Type of Investor: Because all stock price movements can be traced back to earnings, it follows that earnings should be at the heart of every investment decision. But that is not the same as saying that earnings are the only thing to consider when selecting a stock. That is just the starting point. From there, each investor can layer on other concepts such as value, growth, charts etc. to find the stocks that fit their unique approach.
My favorite analogy for this is to say that earnings are to stock investing as flour is to baking. That’s because nearly 100% of baked goods include flour in the recipe. What makes each item unique and delicious is the rest of what you add into it (sugar, flavorings, nuts, fruit, butter etc). Each way works out well, but each starts with flour to make it all come together. So you can apply other factors on top of earnings and estimates to make it suit your unique investment tastes as well.
3) It Works: When you put the philosophy and analogies aside, earnings estimate revisions simply work. This is clearly proven by the market topping +28% average annual returns of the Zacks Rank since 1988. Sure we got our rear-ends kicked in 2008 just like everyone else. But we have topped the S&P 500 in 21 of the last 23 years. And came roaring back in 2009 and 2010.
We always get asked; “If it’s so good, and so well known, why does it still work?” Meaning that most of us are taught in business classes that the market is efficient. So if there are any anomalies that help people beat the market, it will be discovered and eradicated due to extensive use.
The reason it keeps working is because institutional investors are the prime users of estimate revisions and they really haven’t gotten any faster over the years. Here is an overly simplified example:
When they see estimates rise for a stock it will look more attractive in their valuation models and they will want to buy up shares. Since most mutual funds are nearly 100% invested at any time, then they will have to sell something else to get a full position in this new stock. They don’t want to sell out too fast of the other positions or they may end up moving the price lower on themselves. And they don’t want to buy up the new shares too fast or they may run up the price on themselves. Long story short - the accumulation and distribution process still takes most firms 2-4 weeks to fully complete. This still gives more nimble investors ample opportunity to get in early on estimate revisions and enjoy the ride higher as the professionals slowly accumulate their shares. Gladly you can benefit from earnings estimates without spending any money. That is because most websites have earnings estimates data on their sites and stock screeners that can help you narrow in the stocks experiencing the highest level of revisions.
Here is one last tip. Since EER is so powerful on the way up, it is also very beneficial to folks on the way down. Meaning you should immediately sell any stock that has negative earnings surprises or lowered estimates. Yes, you may need to sell out after it falls 5-10% on this news. But better to do that early on instead of selling out for 20-30-40% losses down the road.
Some of My Favorite EER Stocks at This Time
1) Blackrock (NYSE:BLK): Yes, money managers can be slow to react at times as noted above. But they can also be ridiculously profitable. This is especially true as markets are rising, leading to higher AUM fees and leading to higher share prices. BLK is certainly one of the more attractive players in this field.
2) Johnson Control (NYSE:JCI): The manufacturing sector continues to be the strongest segment of the U.S. economy. And auto part manufacturers are even stronger. JCI is riding this trend to new heights. Most signs say more to come.
3) Kelly Services (NASDAQ:KELYA): Thursday’s surprising rise in jobless claims had many investors taking profits in the employment services industry. But don’t be fooled. The rise in claims was due to storms ending in the Northeast, with more people finally filing claims. The four week average of claims clearly shows the trend is improving for U.S. employment. Companies like Kelly are obvious beneficiaries.
4) Newmont Mining (NYSE:NEM): I’m sure you noticed that commodities and natural resources have enjoyed a nice rise over the past couple years. You may have also noticed that stocks like Newmont are seeing a round of profit taking now. This creates a great opportunity to buy more now as long-term fundamentals are still very attractive.
5) Wesco Intl (NYSE:WCC): This stock is in one of our top rated industry groups as most players are experiencing strong earnings momentum. Their latest earnings beat was impressive as analysts are rewarding them with higher estimates for the future. This bodes well for shares and shareholders.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Source: The Case for 'EER' Investing