And so the game continues. Heading into every quarter, analysts tend to tamp down their earnings forecasts, helping many companies to exceed the newly-lowered estimates modestly. During the past few years, this has enabled roughly 55% to 60% of companies beat the consensus estimates each quarter. The early read on the first quarter of 2012: a hefty 80% of companies have topped profit forecasts, according to S&P Capital IQ. (If it holds up, then it will be the best showing in six years, or 24 reporting periods.)
Why such a solid start to this earnings season? Analyst conservatism gets some of the credit, but it's pretty clear that the U.S. economy is holding up OK while many of our key trading partners wrestle with distress.
Indeed, fully 70% of companies that have reported results thus far have topped sales forecasts. As I cautioned a month ago, profit margin gains are likely to prove elusive, so solid sales results will be necessary to fuel bottom-line gains.
Still, macro concerns -- mostly tied to Europe and China -- have pulled the market south even as U.S. corporate profits build a head of steam. In fact, companies that are topping forecasts have seen only a modest initial trading gain: According to Bespoke Investment Group, the average estimate-topping performance has yielded an average 0.8% gain. Any company that has missed forecasts has subsequently fallen by 4% in the next trading day.
NOW is the time to start building your watch list
With the market now in selloff mode, even recent gainers are sliding back. This process could take a while to play out, so this may be a better time to accumulate a list of stocks that you are prepared to start buying, even if you choose to stay on the sidelines at the moment.
Which brings us back to the companies topping sales and profit forecasts right now... When the market stabilizes, investors are likely to circle right back to them and start loading up.
Here's a list of companies that have topped profit forecasts, and the resulting gain or loss since results were released. Each company has a market value of at least $500 million and topped profit forecasts by at least 25%.
Most of these stocks have risen a bit higher, but as you dig into the actual earnings reports, you realize that many of these stocks would have seen much more substantial post-earnings gains if the broader market hadn't been so weak.
To be sure, some of these companies need to deliver more than just a solid quarter to boost investor interest. The New York Times Co. (NYSE: NYT), for example, has yet to deliver top-line growth: Sales are expected to fall another 11% this year to around $2.07 billion. Yahoo's (Nasdaq: YHOO) cost-cutting may have helped the bottom-line, but this is still a company wandering in the forest. And Peabody Energy's (NYSE: BTU) quarterly results are being overshadowed by broader coal industry woes, though as I noted in this piece, the company's outlook may be brighter than many investors suspect.
A little-noticed turnaround
One stock stands out from this group. It remains unloved, falling back after a recent solid quarter, yet is showing all the signs of a turnaround. I'm talking about AMD (NYSE: AMD), which has been slowly generating improving results after new management took the reins last fall. I first suggested investors check out this chip maker last summer, right before the market plunged. Shares have managed to stage a nice rebound since then, but still look quite undervalued.
Toiling in Intel's (Nasdaq: INTC) shadow, AMD will always have to win customers by offering a better price. And that has often meant relatively weaker gross margins, especially as AMD lacks the manufacturing scale that Intel can utilize to hammer down unit costs. So non-GAAP gross margins of 46.0% (160 basis points above consensus forecasts and a similar improvement from a year ago) are notable, and management says that margins will keep rising throughout the year, thanks to a recent renegotiation at a key foundry relationship.
To be sure, PC sales remain weak, and AMD is only expected to boost sales at a 4%-5% clip in 2012 to around $6.8 billion. What does that mean for the bottom line? Analysts are all over the map. The low end of the consensus looks for earnings of $0.50 per share, while the high end forecasts $0.90 per share.
Analysts at Citigroup digested AMD's first-quarter results and came up with a profit forecast of $0.80 a share. They note that the company is finally taking market share (albeit from a low base) in both the server and PC markets. They figure "AMD is now righting the ship and noticeable low-hanging fruit exists just as the cycle is turning." They see shares rising from a current $7.50 up to their $12 price target (a 60% gain).
Risks to Consider: Whenever looking at companies that have topped estimates, you must look at the broader picture to see whether it is part of a broader trend and not the result of short-term benefits.
Action to Take --> As I said earlier, AMD was the name that stood out to me from this list. But that doesn’t mean the other stocks on this list aren't worthy investments, either. The fact that most of these stocks are up modestly despite posting solid quarters tells you that they may be the first to rebound when the market stabilizes. We may not be there yet, but this is a great time to do further research.
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