There is nothing more important to a stock than earnings. That makes earnings season the most important time of the year for the S&P 500.
The companies that miss expectations will be punished while those that deliver big surprises will be rewarded. But with the economy showing signs of weakness in the past month, analysts aren’t expecting a blowout earnings season.
Earnings in the private sector have been trending higher for years, aggressively rebounding out of the financial crisis in 2009. But four years down the line, earnings growth is at the top of a multi-year cycle. Companies have cut all the fat they can cut. Earnings growth needs to come from sales growth, and that has become increasingly difficult with weakness in GDP (gross domestic product).
But there is an upside to these tempered expectations. With early results mixed and analysts’ expectations lowered, it’s going to be easier to impress the Street with a big surprise. Companies that deliver big earnings surprises will be rewarded.
According to research by financial economists, the post-earnings drift is the tendency for a stock’s cumulative abnormal return to drift in the direction of an earnings surprise for several weeks, and sometimes months, following an earnings announcement.
That means an earnings surprise is twice as valuable: a sharp jump in the short run and a tendency to drift higher in the weeks and months to come. Companies that deliver earnings surprises are good for investors.
The six stocks listed below have seen the largest upward revisions in estimates in the S&P 500 going into first-quarter earnings season. That makes them great candidates for big earnings surprises. These are the kind of big gains my colleague Elliott Gue features in his Top 10 Stocks newsletter.
Netflix, Inc. (NASDAQ:NFLX)
This may seem like a crazy pick considering Netflix is up a market-crushing 74% on the year. But Netflix, Inc. (NASDAQ:NFLX) has been making big adjustments to its business model, adjustments that many investors are confident will produce big results. That sentiment is being driven by Netflix’s entry into the more lucrative, higher-margin content business, inking an exclusive deal with Disney and its subsidiaries and producing original content.
This reversal has already had a stunning effect on earnings projections. Ninety days ago, analysts were calling for 2013 earnings of 44 cents per share. Today, they are projecting earnings of $1.19. Their estimate for next year is even more bullish, pegged at $2.71, another 127% increase in earnings. Netflix, Inc. (NASDAQ:NFLX) is still expensive at this level, trading with a forward price-to-earnings (P/E) ratio of 145. But this stock has clear upward momentum.