Earnings have been the most important drivers of stock performance. This is because earnings are the lifeblood of any business, determining its ability, soundness, and growth prospects. Companies with earnings growth potential generally catch investors’ eye due to their solid financial position and growth potential, thereby leading stock prices higher.  

However, many companies use accounting tricks to fatten earnings, thereby leading to inaccuracy. As a result, earnings growth does not reflect the true picture of the company and might hurt investors’ portfolio. Instead, investors’ should look at earnings beat or miss, which drives the real performance of the stock.  

Why Earnings Surprise?

An earnings surprise or an earnings beat occurs when actual or reported earnings come in above the consensus estimate. Wall Street analysts project earnings estimate based on various analysis and insights of companies’ financials and current market conditions. Exceeding this estimate is almost equivalent to beating the company’s own expectation as well as the market perception. In addition, if the margin of earnings surprise is big, it typically drives the stock higher immediately after the release.

Further, earnings surprise has proven its supremacy over the earnings growth metric. History reveals that stocks with solid quarterly earnings growth (say of 20%) tank if they miss or merely meet market expectations, thereby exhibiting a decelerating trend. Plus, growth rates are misleading when seasonal fluctuations come into play. If any company’s Q1 is seasonally weak and Q4 is strong, then it is likely to report a sequential earnings decline.

Thus, more than anything else, an earnings surprise shows the true health of a company. An impressive track in this regard generally acts as a catalyst in sending a stock higher. Earnings surprise history indicates a company’s consistency in beating market estimates. In addition, investors normally have confidence in such companies and expect them to apply the same secret sauce to execute yet another earnings beat in its next release.

The Winning Strategy

In order to shortlist stocks that are likely to come up with an earnings surprise, we chose the following as our primary screening parameters.

Last EPS Surprise greater than or equal to 10%: Stocks delivering positive surprise in the last quarter tend to surprise again.

Average EPS Surprise in the last four quarters greater than 20%: We lifted the bar for outperformance slight higher by setting the average EPS surprise for the last four quarters at 20%.

Average EPS Surprise in the last two quarters greater than 20%: This points to a more consistent surprise history and makes the case for another surprise even stronger.

In addition, we place a few other criteria that push up the chance of a surprise.

Zacks Rank equal to #1 or #2: Only companies with a Strong Buy or Buy rating can get through.

Earnings ESP greater than zero: A stock needs to have both a positive Earnings ESP and a Zacks Rank of #1, 2 or 3 for an earnings beat to happen, as per our proven model.

In order to zero in on those that have long-term growth potential and high trading liquidity we have added the following parameters too:

Next 3–5 Years Estimated EPS Growth (Per Year) greater than 10%: Solid expected earnings growth exhibits the stock’s long-term growth prospects.

Average 20-day Volume greater than 100,000: High trading volume implies that the stocks have adequate liquidity.

A handful of criteria have narrowed down the universe from over 7,700 stocks to around nine.

Here are five out of the nine stocks that fit the bill:

Inogen Inc (INGN - Free Report) : This California-based medical technology company offers oxygen concentrator, cart, carry bags, backpacks, external battery chargers and universal power supply for obstructive pulmonary disease patients. It saw solid earnings estimate revision of 20 cents for this year over the past three months, and has expected earnings growth of 1.44%. The stock has a VGM Style Score of C and sports a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.

Diamondback Energy Inc. (FANG - Free Report) : This Texas-based company is an oil and natural gas company focused on the acquisition, development, exploration and exploitation of unconventional, onshore oil and natural gas reserves in the Permian Basin in West Texas. The stock saw positive earnings estimate revision of 48 cents over the past 90 days for this year and has an expected earnings growth rate of 85.31%. The stock has a Zacks Rank #2 and a VGM Style Score of D.

Radiant Logistics Inc. (RLGT - Free Report) : This Washington-based third party logistics company provides multi-modal transportation and logistics services primarily in the United States and Canada. The stock saw a solid earnings estimate revision by 18 cents over the past 90 days for the fiscal year (ending June 2017) and has an expected whopping earnings growth rate of 309.09%. It has a Zacks Rank #1 with a VGM Style Score of A.

Mitek Systems Inc. (MITK - Free Report) : This California-based company develops, markets and sells mobile capture and identity verification software solutions for enterprise customers worldwide. It saw positive earnings estimate revision of a penny for the fiscal year (ending September 2017) over the past 90 days, and has an expected growth rate of 3.57%. Mitek has a Zacks Rank #2 with a VGM Style Score of D.

LPL Financial Holdings Inc. (LPLA - Free Report) : This Massachusetts-based company provides an integrated platform of brokerage and investment advisory services to independent financial advisors in the United States. The stock saw a solid earnings estimate revision of 28 cents for this year over the past 90 days and has an expected earnings growth rate of 6.01%. The stock has a Zacks Rank #1 with a VGM Style Score of D.