Is the Cream Rising to the Top this Earnings Season?

So far approximately 43% of the stocks in the S&P 500 have reported second quarter earnings results—at least that was the case at the end of the day on Friday. We have seen earnings big upside moves from big names such as Alphabet (Nasdaq: GOOGL) and Twitter (NYSE: TWTR), and we have seen surprises to the down side from companies like Boeing (NYSE: BA) and Caterpillar (NYSE: CAT).

Of course the list of companies that have reported and moved sharply in one direction or the other is far more extensive than those four stocks, but you get the idea—there have been positive surprises and negative surprises. As for the overall results, the number of companies beating earnings and revenue estimates are in line with the historical averages.

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According to a recent report from Lipper, 75.2% of companies have beaten EPS estimates so far. That is in line with the 76% average for the last four quarters and above the long-term average of 65%.

The revenue numbers show that 60% of companies have beaten top line estimates and that is in line with long-term average of 60%, but it is slightly below the 63% average for the last four quarters.

One thing that jumped out to me about the companies I listed in the first paragraph was the fundamental ratings. I use Investor’s Business Daily pretty extensively in my research. When I want a quick snapshot of what a company’s fundamentals look like, I use IBD’s EPS rating and SMR rating. The EPS rating measures the earnings growth of each company based on the most recent quarterly report as well as the average earnings growth for the last three years. The rating is on a scale of 1 to 99 with 99 being the best and 1 being the worst. It is a comparative rating system in that it compares the company’s earnings growth to all the other companies in the database.

The SMR rating measures the sales growth, profit margin, and return on equity of companies and the compiled data is given a grade from A to E with A being the best.

With this information in mind, I put together the table below for Boeing, Caterpillar, Alphabet, and Twitter. I highlighted areas where the EPS rating was in the 20% and the A SMR ratings. This is similar to the process I go through each day for trade ideas and weekly for longer term investment ideas.

Sure the table only represents four stocks, but I couldn’t help but notice some earnings reports from Monday night and Tuesday morning. I had two stocks recommended in my newsletter and had looked at several of the other companies as well. In this case I did the table exactly like I would my nightly research.

A SMR ratings and EPS ratings over 80 get the dark green highlight while 60-79 EPS ratings and B SMR ratings get the light green highlight. EPS ratings in the 41-59 range are left white as are C SMR ratings. EPS ratings in the 21-40 range get orange highlights along with D SMR ratings. EPS ratings at 20 or below get red highlights and an E SMR rating would as well.

Now that you have the highlighting system, take a look at the table below. The returns were a snapshot from Tuesday morning and they are only showing the gains or losses from the morning trading session.

Do you see the pattern? There are three stocks that have orange or red EPS and SMR ratings—Beyond Meat, McDermott, and Under Armour. All three were getting hit pretty hard along with GrubHub which had an average EPS rating and a slightly above average SMR rating.

The two stocks I had recommended to my subscribers were Medpace Holdings and Trex and both were up sharply. The one stock with dark green marks for both the EPS and SMR ratings is Mastercard and it was down slightly, but the market was down slightly as well. We see DR Horton was up 5% and Pfizer was down 5.33% and they both had mixed highlights of dark green and light green.

Yes this only represents one day, and no I am not doing this to pat myself on the back. What I am noticing more this quarter than I have in the last few quarters is that the better the fundamental ratings are heading in to the report, the better the results have been.

This could mean that we are shifting out of the extreme bullish phase the market has been in since the Christmas Eve low where almost all stocks have been lifted by the overall market trend. Personally I am always very selective about the stocks that I invest in and I use a table like the one above to get my preliminary list of stocks. I then add a few sentiment indicators to the table and I look at the charts to see what the technical analysis looks like.

If we are in the last stage of the bullish phase that has essentially been going on since 2009, it could be significantly more difficult to pick winning stocks. I highly recommend that investors use a process like the one I just laid out to pick their individual stocks. It isn’t a fool proof system and I had recommended iRobot (Nasdaq: IRBT) and Rollins (NYSE: ROL) based on the same system. Those two stocks dropped sharply last week after their earnings reports. I also had a couple of other stocks that did well last week and that helped offset the losses.

The point is that if you use a system that looks at the fundamentals, the sentiment, and technical analysis—you should end up with more high quality companies in your portfolio.

About Rick Pendergraft

Rick has been studying, trading, analyzing and writing about the investment markets for over 30 years. He has worked for some of the largest financial publishers in the world and he has been quoted in the Wall Street Journal, USA Today, the New York Times and the Washington Post. In addition, he has been interviewed on Bloomberg, CNBC and Fox Business News. Rick’s analysis process includes fundamental, sentiment and technical analysis. Rick started college as an education major, wanting to teach economics, but eventually changed to majoring in Economics and received a Bachelor of Science in Economics from Wright State University. His desire to inform and educate people is at the heart of his writing.

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