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Friday, May 17, 2013 - 13:00
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Thursday, July 25, 2013 - 02:57
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Friday, May 17, 2013 - 13:00

This Classic Value Stock Has Up To 57% Upside

Friday, May 17, 2013 - 1:00pm

The first-quarter earnings season is almost over, with more than 90% of the S&P 500 reporting. Although the results have been far from terrible, there hasn't been a lot to get excited about.

Earnings are up 3.3% from last year, while revenue is down 1%. Those numbers have 65% of the S&P 500 beating expectations, below the average beat rate of 70% in the past four quarters. In spite of those lackluster results, some companies still managed to deliver positive earnings surprises.

For example, take Netflix (Nasdaq: NFLX). With the successfully execution of a broad-based turnaround strategy, Netflix sneaked up on the Street and delivered a huge earnings surprise that sent shares soaring for the second quarter in a row.

But if you missed out on those big gains, don't worry -- there is a little-known market phenomenon that should continue to support Netflix's stock. In the pattern known as post-earnings drift, a stock is likely to continue rising for weeks and sometimes even months after reporting an earnings surprise.

When a company reports an earnings surprise, that new information is quickly absorbed by the market and usually gives shares a big boost. But according to research on post-earnings drift, firms with good quarterly earnings reports tend to see returns drift upward for at least 60 days after their announcements. Similarly, firms that report disappointing earnings tend to drift lower for a similar period.

This phenomenon is on display in Netflix's chart. After the company's huge earnings surprise from late January lifted the company from below $100 to $169, shares continued to drift higher to $196 in the next month, an additional 18% gain.

The post-earnings drift means investors don't have to search for a needle in a haystack and identify companies on the cusp of a big earnings surprise. They can instead focus on companies that have already reported great quarters and jump on the momentum bandwagon.

With the post-earnings drift in clear focus, here is a list of the seven S&P 500 companies that most exceeded analysts' first-quarter estimates.

From the group, I have chosen to highlight Netflix for its upward momentum and homebuilder Lennar (NYSE: LEN) because of its exposure to the ongoing housing market recovery.

Netflix has been one of the best turnaround stories of 2013, logging an eye-popping gain of 154% as the top performing stock in the S&P 500.

That upward momentum has been driven by two things. The first is two huge earnings surprises, beating expectations by 208% in the fourth quarter of 2012 and then following that up with a 72% surprise in the first quarter. The second is massive upward revisions in earnings estimates, with the current-year estimate jumping from $1 per share 90 days ago to $1.60, a 451% growth projection from last year.

Looking forward, analysts expect Netflix's earnings to grow another 93% in 2014, with earnings per share (EPS) of $3.09. But though Netflix has already seen huge gains, the upward momentum of the post-earnings drift should keep shares on the move.

Lennar has also been burning up the charts, gaining 50% in the past year and 150% in the past two. Much like Netflix, those gains have been fueled by big earnings surprises: an average beat of 46% in the past four quarters, with the most recent results beating expectations by 100%.

Analysts have been quick to revise earnings estimates higher, calling for EPS this year of $1.76, which would amount to a 105% increase from 2012. Analysts are calling for earnings growth of 40% in 2014.

With clear earnings momentum in hand, this homebuilder continues to benefit from the housing recovery and the post-earnings drift.

Risks to Consider: Stocks with large gains from an earnings surprise are susceptible to abnormal volatility as "fast money" flows in and out of shares looking for a quick gain.

Action to Take --> In spite of a lackluster earnings season, these seven stocks reported huge earnings surprises and are in position to benefit from the post-earnings drift.

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Michael Vodicka does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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