Look for earnings surprise breakouts

There are always some stocks that have significant earnings surprise either to upside or downside. Such earnings surprises lead to rallies in such stocks.

PEAD (Post Earnings Announcement Drift) is a very well known and extensively studied market anomaly. Ball and Brown first documented the PEAD phenomenon in 1968. Since then hundreds of thousand studies have confirmed their findings across world markets.

As its name suggests, the PEAD is the tendency of stocks that beat earnings expectations to continue to drift upwards after the announcement, or likewise for stocks that miss earnings to continue to drift downwards.

Everyday during earnings season number of companies surpass earnings expectations or miss earnings. When earnings is announced it is compared to existing expectations. Iif the earnings is a major surprise to the market then the stocks reacts immediately to that news. Most of the time the stock with significant earnings surprise will make 40 to 100% move on earnings day itself. Depending on market conditions these stocks can go in to multi week rally. In uncertain market conditions, they tend to pullback and go sideways or form range and then breakout nearer to next earnings.

When looking for PEAD candidates , stocks with first or second significant earnings surprises and significant earnings growth lead to big moves. After a few quarters of earnings acceleration, everyone notices it and the reaction is more muted as the earnings get discounted. Very few stocks can consistently surprise on upside for more than few quarters.

There is a cockroach effect in earnings trends. One earnings surprise is typically followed by many more earnings surprises. When you focus on first earnings acceleration there is good chance your stock will have more such earnings. So effort spent in researching stocks during earnings season can pay you off for many quarters. The structural factors which contribute to earnings acceleration do not disappear in one quarter. That is why earnings trends persist and price trends persist.

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