Industry Trends: Using Earnings Beats to Predict Analyst Upgrades

by: Todd Campbell

Wall Street analysts have taken their fair share of knocks over the past decade. Why? Because analysts often get too close to corporate cheerleaders and too complacent in their view. So, most investors read analyst reports with a healthy grain of skepticism. After all, analysts are human and make mistakes just like you and me. Savvy investors can profit from them.

Despite risks investors can't dismiss analysts altogether because they still influence portfolio managers - and those portfolio managers influence stock prices.

The good news is this creates an opportunity for savvy investors willing to track how industries are performing relative to Wall Street forecasts. Specifically for those willing to make assumptions about what this means for future analyst upgrades and downgrades.

In my book "Your Guide to Better Stock Picks," I talk about the importance of earnings per share, or EPS, beats in finding great management teams. Often, the best stocks are those with management teams who understand investor's reward consistent outperformance. And a great way to measure outperformance is by tracking a company's ability to exceed street forecasts.

But you don't have to stop there. You can take the analysis a step further and consider EPS beats across industries too. This shows you where trouble spots are developing and where business is improving. More importantly, it hints to where the Street is too pessimistic and likely to upgrade stocks and increase earnings estimates.

So, where are analysts too complacent? E.B. Capital Markets, LLC analyzed the past four quarters of EPS reports across more than 1500 stocks in its universe. Which industries have done the best job at beating over the past year? Wholesale industrial equipment stocks, which includes Airgas (ARG), Applied Industrial Tech (NYSE:AIT) and DXP Enterprises (NASDAQ:DXPE), and security and protection services, which includes Brinks (NYSE:BCO), Geo Group (NYSE:GEO), L 3 Communications (NYSE:LLL) and Lojack (NASDAQ:LOJN).

And, there are a number of surprising trends emerging too. Healthcare plans, including United Healthcare (NYSE:UNH) and Wellpoint (WLP) have, on average, beat the street in 3.67 of the past 4 quarters - well above the 2.51 universe average. Advertising agencies, including Interpublic Group (NYSE:IPG) have similarly done nicely this past year, beating analysts in 3.4 of the past 4 quarters. And, money center banks - dogged by negative media chatter and poor seasonality - have outpaced in 3.11 of the past 4 quarters. A couple strong performers in this group include JP Morgan (NYSE:JPM), Keycorp (NYSE:KEY) and PNC Financial Services (NYSE:PNC).

What industries are coming up short? Silver, drug delivery, wireless communications and gold stocks have done the worst job at over-achieving.

In looking over the list, you can also draw some other conclusions. A lot of healthcare stocks, for example, have outperformed. While biotech has lagged, medical instruments, including Baxter International (NYSE:BAX), and medical equipment, such as St. Jude Medical (NYSE:STJ), have led. And, strength across financials has been widespread. Staffing stocks are outperforming suggesting job trends remain solid and underappreciated. And semiconductor strength suggests consumers insatiable gadget appetite is translating into bigger than forecast profits.

As you navigate the market, keep in mind where analyst upgrades may work in your favor. Use those industries as your hunting ground for new ideas. If you do, you'll gain an investment edge.

Disclosure: I am long KEY, JPM, PNC.

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