I’ve been writing in recent weeks about stock-picking models that look for earnings surprises and earnings upgrades as a source of superior returns. So far this year the returns have been stellar. But there are other ways of reading between the lines of smart money analysis and one of them is to look for shares that are attracting the highest number of upgraded earnings forecasts over the past month.
The advantage of looking at the net number of improved forecasts is that it offers a view of shares where the broker consensus could be changing its opinion. Updated ‘buy’ and ‘sell’ notes generally emerge ahead of, or just after, trading updates and results news and inevitably there has been research into their impact and whether there is space to profit from them.
Studies by Womack (1996) and Barber (2001) both found that companies with high levels of upgraded recommendations witness rapid rises in share price followed by a short period of upward drift – something commonly known as price momentum. But unlike other momentum strategies which can run for several months, this short, sharp price rise means that holding periods can be equally short, making the trading costs potentially high. But for investors who may have been considering buying the stock anyway, bumper upgrades could be an ideal entry point.
Understanding broker notes
While tracking the market for companies that are winning the hearts of large numbers of analysts sounds like a straightforward plan, there is a need for caution. On a structural level, of all the thousands of stock recommendations made each year, only around 10% of them advise selling shares. This rather ridiculous imbalance is matched by research showing that analysts are predisposed to making bullish recommendations for all sorts of reasons. After all, upsetting clients and encouraging investors to sell shares is hardly a recipe for a successful career in the City. In part, this screening strategy compensates for that problem by looking for high numbers of EPS upgrades rather than just one or two potentially rogue revisions. It’s also worth noting that looking for bumper levels of recommendation upgrades is a strategy that gravitates towards companies with large broker followings; so small-caps rarely get a look-in with these tactics.
Over the past month, betting group Betfair (LON:BET)…
