3 Stocks Rising on Earnings Revisions

03/12/2012 7:30 am EST


Upside earnings revisions, along with some technical indicators, are how advisor Mike McGervey determines portfolio investments. He shares details about his method with MoneyShow.com, and discusses three current holdings.

Kate Stalter: I’m speaking today with Mike McGervey of McGervey Wealth Management.

Mike, one of the metrics you use is earnings revisions on individual stocks, taking a bottom-up approach. Tell us a little bit about what you’re seeing.

Mike McGervey: Sure, Kate. Upward revisions to estimated earnings are a great predictor of future price for us. What we see in revisions to the upside is, many times, they’re precursors to positive earnings surprises.

Positive earnings surprises are not only felt immediately, as I’m sure as you may know, but the effects of a positive earnings surprise can last well up to a year. Oftentimes, they’re followed by more earnings surprises, for example.

And as a result of this, it puts us in a position to build a solid book of stocks, if you will, that we can then filter fundamentally, take it a step further. And even as great as these securities may be, we can then utilize technical analysis to enhance the timing of our buy decisions, and conversely, to provide a sell-side discipline on the downside.

Kate Stalter: You just mentioned some of the technical indicators. Which ones do you track, and what are they showing you these days?

Mike McGervey: We use a variety of different things. Moving averages at the very basic level. Relative strength index is very helpful. Even using S&P yields to some extent. And some other crossovers can be very helpful.

From a bottom-up approach, one of the reasons we do look at revisions to the upside is: At a basic level, positive earnings surprises oftentimes occur when actual reported earnings are above the forecasted earnings per share, and what we see is stock prices of firms that have perhaps more significant earning surprises show above-average performance. And as I mentioned earlier, the surprises can have a longer-term impact on these securities.

Kate Stalter: Do you include the outlook in the earnings surprise? Because that seems to be also a factor that can propel a stock either up or down.

Mike McGervey: Sure, and one of the things that I would mention about the outlook is the market is very forward-looking, as you know, and prices are really established through consensus expectations for earnings.

And I know we’ve been talking quite a bit about earnings surprises. One of the things that we look for that sometimes gives us a precursor to earnings surprises is actually revisions of the estimates to the upside.

When we see significant revisions to the upside, that’s an indication to us that many analysts are—use the word, “scrambling,” perhaps—to change consensus estimates when there’s anticipation of a big surprise. So a lot of times, it’ll give us a little more advance notice.

Kate Stalter: Can you give us some specific examples, then, over the last few weeks or months, of stocks that have met some of your criteria, technically and fundamentally?

Mike McGervey: Well, you know, several holdings have met the criterion, and they also meet the technical criteria as well.

One is Genesco (GCO). That’s a retail apparel group, and what we see in them is they not only meet the upside revisions, but they also have great fundamentals.

Retail apparel is also in the top 20% of industry groups, so there’s other fundamental factors that go along with them as well. Plus, they meet the technical criteria.

Sunoco Logistics (SXL) is another one. They also have a nice dividend, somewhere north of 4%, which not only helps price appreciation, but it’s a little something in addition. It’s perhaps a little more recession-resistant than others. Group 1 Automotive (GPI) would be another example of that.

What I would say is: The technical piece, by utilizing the analysis to enhance the timing of buy decisions, and obviously to provide that sell-side discipline on the downside, is really critical. And we recognize that clients today want to dynamically manage risk within their portfolio, while still being able to add value when the market conditions permit.

And certainly, if you look over the last 12 years, there have been great times where you could make money. But by doing this dynamically, that certainly would put us in a position where we would be able to protect against a lot of the downside and some of the more significant declines.

The way I look at it, this disciplined approach helps us ensure that the investment decisions we make are based on solid reasoning. They’re not based on emotional reactions. And we’ve eliminated a lot of client anxiety from this, as they know that we’re proactively responding to what the market is actually doing, versus speculating on where it might be headed.

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