When we interviewed J. Stephen Castellano of Ascendere Associates last month about his Systematic Long-Only model, we found his take on consensus estimates interesting. Consensus estimates (see definition) are provided by most media outlets like Yahoo Finance that have financial news and stock information. What was interesting about the Ascendere model wasn’t that he used these estimates, but his reasoning behind their use.
To recap, Stephen stated:
Our models for the Systematic Long-Only strategy measure analyst revision momentum — the rate of change and the relative position of analyst revisions — as opposed to their accuracy. We are not so much concerned by the accuracy of the estimates as we are with the general direction and relative level of the changes. Deservedly or not, stock prices in the short term do tend to fluctuate in relation to analyst revisions as opposed to any intrinsic value, so this figures into our quantitative rankings.
A good example of this logic at work is in the stock Lam Research Corporation (Nasdaq: LRCX), a position that was added to Castellano’s Systematic Long-Only model late December. According to Reuters, in October consensus EPS estimate for LRCX for the quarter ending December 2010 was $1.42. It was then revised up to $1.57. The company’s 2011 and 2012 fiscal year EPS estimates were also revised up after the company beat estimates for the quarter ending September 26th, 2010. LRCX’s stock price has also gone up, right along with consensus estimates. On October 1st, LRCX closed at $42.19. On December 29th, it closed at $52.27.
Another example of this correlation can be found in RPC Inc (NYSE: RES), which was added to the model at the beginning of December. Two months ago, EPS estimates for the quarter ending December 2010 were $0.26. Now, the estimates have reached $0.34. So how about the stock price? On October 1st it closed at $20.84 per share, and on December 10th, before the stock split, it closed at $31.63 per share.
While there are certainly many other factors at play when a growth stock shows momentum, and one certainly shouldn’t assume that the correlation between analyst revisions and stock price always holds, these two cases were an interesting illustration of the dynamic.
See more about Stephen Castellano’s Systematic Long-Only model on Covestor.
*Price information courtesy of Yahoo Finance.
