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There are many great fundamental stock picking masters out in the investing world including Warren Buffett, Joseph Piotroski, Benjamin Graham, and more. Sometimes the systems involve quantitative and qualitative analysis, and other times the premise is quite simple. This is one of the more simple ideas that has theoretically produced superior results over the past 13 years (Source: AAII tracking 63 different strategies).

The idea is simple: When analysts raise forecasts for this year and next, perform your due diligence and then buy as the stock price drifts upward. This strategy runs counter to the 'strong efficient market theory' in that future value is understated in current prices and not immediately reflected.

This is not the first time that stock selection is based on a change in analyst forecasts. 'Boni and Womack' (2004) and 'Ang and Ciccone' (2001) wrote papers that highlighted the advantage of using analyst ratings and forecasts. One paper discussed the benefit of buying upgraded stocks while the other talked about stocks with low earning surprises with analysts that were able to have a tight consensus. (Read about the 12 Stocks Upgraded by Analysts that Hit Their Targets)

We will run a stock screen on upward revised stocks with some attention to relative strength and market cap.


Screening for Revised Stocks
We will use Zacks' stock screener to find our upgraded stock picks.

For this screen we want to find stocks at least in the small cap category of at least 300 million. Next we will screen for annual earnings of at least $1 per share. If we scan for EPS too low, a very minimal change in overall EPS can spike the annual forecast. We will select at least five analysts, since too few people covering a stock can lead to heightened risk if one analyst raises estimates. There is safety in numbers. Then we will search for stocks with raised estimates for this year and next. Finally, we are looking for some very short term relative strength where prices are up for the week.

  • Market Cap > 300 million

  • Annual earnings > $1/share

  • 5 or more analysts

  • %10 forecast earnings jump in both this and next year (Upgrade over past 4 weeks)

  • Price up for the week

List of Upward Revised Stocks

Ticker

Company

Market Cap

P/E

Price

DIOD

Diodes Incorporated

1340.86

17.99

30.22

FEIC

FEI Co.

1336.1

26.05

34.65

TAL

TAL International Group, Inc.

1055.14

18.28

34.18

OVTI

OmniVision Technologies Inc.

1714.58

19.14

30.81

DELL

Dell Inc.

29803.68

11.44

15.44

CLF

Cliffs Natural Resources Inc.

13123.36

12.93

96.88

IRF

International Rectifier Corporation

2276.78

15.9

32.6

EL

Estee Lauder Companies Inc.

18329.4

30.24

92.84

WLK

Westlake Chemical Corp.

3177.12

14.41

48

IPGP

IPG Photonics Corporation

2538.13

48.04

54.28

AMAT

Applied Materials, Inc.

21697.06

16.26

16.42

KEX

Kirby Corporation

2971.43

25.7

55.52

MASI

Masimo Corporation

1790.07

24.84

30.06

CPO

Corn Products International Inc.

3587.41

21.56

47.44

GNRC

Generac Holdings Inc.

1209.96

17.92

BRKS

Brooks Automation Inc.

866.16

9.95

13.24

HOC

Holly Corporation

3036.16

29.41

57.06

NVLS

Novellus Systems, Inc.

3694.18

14.63

40.96

ROC

Rockwood Holdings Inc.

3495.03

16.5

46.2

DE

Deere & Company

37709.51

17.98

89.55

UAM

Universal American Corp

1661.1

8.82

21

WYNN

Wynn Resorts Ltd.

15627.62

98.5

126.08

AET

Aetna Inc.

15079.77

9.1

37.69

RBCN

Rubicon Technology, Inc.

545.05

19.16

23.76

Note that none of these stocks are below small caps, which might limit our upside potential - but also reduce downside risk. As reported on by Fama and French, smaller stocks have higher annualized gains than larger cap. (If you like large and mega caps, some momentum picks are here)

A Few Financial Metrics (data supplied by FINIZ)

  • The only stock with a big dividend is TAL International wtih a 5.27% yeild

  • The only stock with a double-digit short percent is Masimo with 12.06%. However, the highest short ratio is Kirby wtih 15 days to cover.

  • High expectations don't always come true, but stocks with high forecasted annualized gains averaged over the next 5 years are Holly Corp. (52.50%), Wynn Resorts (41.16%), and Rubicon (26.67%).

Increased Reward and Reduction in Risk?

Sometimes, systems that have increased reward come with increased risk. This is the theory of Beta, which has been challenged of late. There is also Alpha, which is the gain associated with a stock that cannot be linked to leveraged market volatility. This strategy that involves buying forecast upgrades seems to have high Alpha.

Over the past 13 years that this system has been tracked by AAII, only two years were associated with any loss. And in 2008, the 18.4% drop associated with this technique was less than half of the 38.5% drop in the S&P 500.

Do you own any of the above stocks or have a comment you’d like to make on one of the companies? Do you have a different view of this simple system you'd like to respectfully share? Is there a certain sector, industry, or market capitalization that you’d like me to run a ‘upward revised forecast’ screen on?

(You might also like to read on whether you should buy into the next 'Hot Sector')

Source: 23 Stocks Spiking on Raised Analyst Forecasts