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Best and Worst Stocks for Earnings Season

The third calendar quarter ends Wednesday, and earnings season — a loosely defined period during which many companies report financial results — starts in early to mid-October. Wall Street’s published forecasts suggest that operating earnings underlying the S&P 500, the index that represents most of America’s stock ticker market by value, will have fallen 9% from a year ago. That would be a sharp improvement from prior quarters; operating earnings fell 19% year-over-year in the second quarter and 39% in the first, and they disappeared altogether in the fourth quarter of 2008.

Despite the improvement, investors might be disappointed if third-quarter earnings merely meet forecasts. In the second quarter, nearly three-quarters of companies posted positive earnings surprises, whether from cost-cutting or careful management of their expectations (but rarely from growth, as few companies beat sales estimates). stock ticker valuations suggest buyers are betting on another round of positive surprises. The S&P 500 lately has traded near 20 times its forecast 2009 earnings. Its historical average is less than 15 times earnings.

With so much seemingly riding on surprises, consider a statistical clue that can help predict which companies will please Wall Street and which will disappoint. It’s not a sure thing, but it can bend the probabilities in an investor’s favor. It has to do with analyst disagreement.

stock tickers with analysts’ earnings forecasts that are broadly scattered tend to underperform the broad market, according to a study published in 2007 in the Journal of Finance and written by Anna Scherbina, a professor at the University of California, Davis. There are a couple of theories on why. The most convincing of them holds that companies with good news share all the details with anyone who’ll listen, and those with bad news keep mum. The difference in information flow leads to agreement among analysts over companies that are performing well, and disagreement over ones that might be struggling.

Below I’ve attempted to apply the study finding to S&P 500 companies, focusing on the 211 of them that are expected to earn at least 50 cents a share in their current fiscal quarters, and whose earnings consensuses are based on at least five estimates. Statisticians use a measure called standard deviation to judge the degree of scattering within a group of results. For each of my 211 companies, I divided the standard deviation of the current-quarter earnings consensus by the consensus itself, and expressed the result as a percentage. These ranged from less than 1% to more than 46%. A lower percentage suggests more agreement among analysts, and according to the study, an increased likelihood of market-beating returns over the next six months. A higher percentage should be read as a warning sign — again, only one piece of evidence among many that investors should consider.

Below are listed the top 10 and bottom 10 companies from my comparison.

Top 10
Company Ticker Current-Quarter
EPS Consensus
(excl. special items)
Standard
Deviation
Std. Dev. /
Consensus*
C.R. Bard BCR 1.28 0.01 0.8
Hewlett-Packard HPQ 1.12 0.01 0.9
Praxair PX 1.00 0.01 1.0
Baxter International BAX 0.97 0.01 1.0
McCormick & Company MKC 0.90 0.01 1.1
Philip Morris International PM 0.90 0.01 1.1
Abbott Laboratories ABT 0.90 0.01 1.1
Wal-Mart Stores WMT 0.81 0.01 1.2
Medtronic MDT 0.75 0.01 1.3
Torchmark TMK 1.49 0.02 1.3
Bottom 10
Company Ticker Current-Quarter
EPS Consensus
(excl. special items)
Standard
Deviation
Std. Dev. /
Consensus*
Stanley Works SWK 0.62 0.10 16.1
XL Capital Ltd. XL 0.52 0.09 17.3
CONSOL Energy CNX 0.65 0.12 18.5
Apache APA 1.47 0.28 19.0
Whirlpool WHR 0.81 0.16 19.8
Devon Energy DVN 0.86 0.21 24.4
M&T Bank MTB 0.73 0.19 26.0
Hartford Financial Services Group HIG 0.79 0.25 31.6
CF Industries Holdings CF 1.13 0.41 36.3
Freeport-McMoRan Copper & Gold FCX 0.93 0.43 46.2

* lower = more analyst agreement

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