Use
Surprises to Pick Stocks
Here’s a stock picking strategy that doesn’t require scrutinizing
financial statements or checking price/earnings ratios, or even
worrying about how economic ups and downs might affect a company’s
outlook.
Instead, it’s based on picking stocks based on earnings surprises, one
of the few reliable predictors of future stock prices.
An earnings surprise is the difference between a company’s reported
earnings and the number that stock analysts were expecting. All else
equal, positive surprises (reported earnings beat forecasts) drives
share prices up, often for extended periods. Conversely, negative
surprises (earnings below forecasts) drive share prices down.
Blogger's Surprise Strategy
Hedge funds, said to rely heavily on surprises to power their
computer driven stock selection strategies, keep the details secret.
But that’s not the case for Pradeep Bonde, who publishes a blog called
StockBee (StockBee.blogspot.com).
Bonde follows a strategy based on tracking surprises that, reportedly,
has been producing high double-digit annual returns for several years.
I can’t verify Bonde’s returns, but his ideas are intriguing enough to
share. If you’re interested, give it a spin with paper (imaginary)
trades to see how it works for you. Here are the details.
Finding Surprise Stocks
Bonde monitors quarterly earnings announcements, which for the
most part, happen when the markets are closed. Bonde says that
Investors Business Daily (www.investors.com)
and the Wall Street Journal (www.wsj.com)
do the best at presenting earnings report numbers, but those sites
require a subscription. You can also monitor the reports on free sites
including the Earnings Analysis report on Zacks (www.zacks.com),
the Earnings section of StreetInsider.com (www.streetinsider.com),
and the Market Pulse report on MarketWatch (www.marketwatch.com).
Bonde starts by looking for stocks with a minimum 100% earnings
surprise. That is, reported earnings must be a least double consensus
(average) analyst forecasts. Bonde cites studies that found that the
bigger the surprise, the higher the potential share price gain. One
further point: the latest earnings number must be at least five cents
per share. Bonde doesn’t think that a 100% surprise means much if the
forecasts only called for earnings of a penny or so per share.
A strong earnings surprise is just the start. Bonde requires several
additional conditions before he’ll buy a stock.
First Surprise
Some companies routinely beat analysts’ forecasts. For them, another
positive surprise isn’t news. Thus, Bonde looks for real surprises,
that is, stocks that haven’t reported consistent positive surprises in
previous quarters. You can see a firm’s surprises for the last four
quarters in the Earnings History section of Yahoo’s Analyst Estimates
report (finance.yahoo.com).
Guidance
Most firms forecast the next one or two quarters’ sales and earnings
when they announce the most recent quarters’ results. The big earnings
surprise doesn’t mean much if company management expect a slowdown in
future quarters. Disqualify stocks if the company’s guidance for
future growth isn’t consistent with the just reported results.
Small Stocks
Shares outstanding are the total number of shares issued by a company.
But company insiders are only allowed to trade their shares under
certain conditions. Thus shares held by insiders are not considered
available for trading. Float is the number of outstanding shares
not held by insiders, and thus, are available for trading. Floats
can run into the hundreds of millions of shares. For example, Apple’s
float is 900 million shares. Bonde prefers floats below 25 million,
and ideally below 10 million. He avoids stocks with floats above 100
million shares. You can see the float in the Share Statistics section
of Yahoo’s
Key
Statistics report.
Price Move
Bonde requires qualifying stocks to move up at least
8% after the earnings announcement
containing the surprise for stocks that were trading under $63. For
stocks that were trading above $63, a $5 price jump is sufficient.
Trading Volume
Besides for the price jump, Bonde wants to see trading volume (number
of shares traded daily) on the day following the news jump to several
times higher than before the announcement.
You can see the current day’s trading
volume, as well as the average volume over the past three months on
Yahoo’s
Summary report.
Previous Action
Bonde says that in terms of previous price action, the best candidates
are stocks that basically moved sideways in the months previous to the
surprise announcement.
Selling
Bonde typically holds his stocks for periods ranging from two days to
several months. However, he sells immediately if a stock drops by
6% or more after he buys. If it moves up,
Bonde sets sell price targets based on the earnings surprise
percentage. For instance, for a 100% surprise, he’ll sell 25% of his
holding when he achieves a 50% share price gain, and then sell another
25% when it goes up another 25%, and so on. However, for a 200%
surprise, he’ll wait until he achieves a 100% gain before selling 25%
of his holding. Bonde also sells when the stock stops steadily moving
up in price, even if it hasn’t reached his target.
I don’t have room to detail all of the ins and outs of Bonde’s
strategy. You can find out more by reading his
Blog,
or you can be privy to his trades by subscribing to his premium
service, which costs $150 per year.
By the way, I learned of Bonde’s work after Charles E. Kirk,
proprietor of The Kirk Report (www.thekirkreport.com),
posted an online question and answer session with Bonde.
published 2/28/10
