Author: Bob Gay, GEARS
Covestor Model: Earnings Surprise
Disclosure: Long ROP, CKH, AGCO, LNN, AME, WBMD
I created the Earnings Surprise Model to exploit the earnings surprise pattern in fundamental data. The components of the surprise pattern are rising sales growth, higher gross profit margins, high and falling SG&A expenses, lower financing costs and positive and rising cash flow returns. This pattern repeats itself frequently, not only across companies but also within the company record as economic cycles and product cycles affect growth.
The surprise pattern measures an accelerating company. This accelerating phase of the company growth cycle is when the company produces a series of positive earnings surprises and often when the shares produce superior returns.
Depressed share price is also an important component of the Earnings Surprise Model strategy. The surprise pattern is not a predictor of the future, but rather a measure of the current evident trend. That trend can reverse even in the short term and the depressed share price discipline helps limit the downside risk.
The population of companies with surprise patterns in the fundamental data declined in our recent reports. However, the recent weakness in share prices is producing more buys. That is the opposite of last quarter when the population of surprise patterns was higher but depressed share prices were few.
That induced me to sail a bit too close to the wind by buying accelerating companies in the higher-risk low-profit group. That hurt me when negative news sent shares lower and sharp reversals in the fundamentals prompted sell decisions for Nektar Therapeutics (NASDAQ: NKTR), Energy Conversion Devices (NASDAQ: ENER) and Anadagics (NASDAQ: ANAD) at substantial losses. Sell decisions based on extended share prices were executed for Thermo Electron (NYSE: TMO), Badger Meter (NYSE: BMI), LTX Credance Corp (NASDAQ: LTXC), Linear Technology (NASDAQ: LLTC), Lattice Semiconductor (NASDAQ:LSCC), Applied Micro Circuits (NASDAQ: AMCC), Pericom Semiconductor (NASDAQ: PSEM) and Blackrock (NYSE: BLK).
The Surprise strategy is a perpetual start-up model. Because extended shares are sold to provide room for new surprise patterns, the model is always making trades in stocks in the Surprise category. New buy decisions last month were Roper Industries (NYSE: ROP), Seacor Smit (NYSE: CKH), Agco Corp (NYSE: AGCO), Lindsay Manufacturing (NYSE: LNN), Ametec (NYSE: AME), and WebMD Health Corp (NASDAQ: WBMD).
More buying opportunities are appearing with the recent correction in the market. Shares are lower, so I believe it’s time to buy.
To create a successful stock portfolio requires attention, consistency and discipline. Most of all, it requires an information edge. Years of research have shown that shares of companies that are profitable with rising shareholder wealth perform better.