CNL Cleco Corp.

CHICAGO, March 16, 2011 /PRNewswire/ -- Stocks in this week's article include: Brightpoint, Inc. (NASDAQ: CELL), Cleco Corp. (NYSE: CNL), CVR Energy, Inc. (NYSE: CVI), MasTec, Inc. (NYSE: MTZ) and Navios Maritime Holdings Inc. (NYSE: NM). Kevin Matras shows how to focus on the right stocks with the right kind of surprises.

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Screen of the Week written by Kevin Matras of Zacks Investment Research:  

An earnings surprise is simply when a company announces earnings above or below the consensus estimate going into the report.

If the company reports earnings above expectations, that's a positive surprise. If it reports earnings below expectations, that's a negative surprise.

In short, an earnings surprise is a signal of what a company's future earnings are going to look like or could look like. An upside surprise could mean that the company will see better earnings than first expected. And a downside surprise would likely be interpreted that the company will see earnings lower than first expected.

The magnitude of the surprise will of course determine the size of the reaction that the market takes.

The idea, though, is that it's not just the extra dollars and cents that the company makes during the period, but what it implies for future earnings periods as well.  

A positive surprise coupled with downward guidance will usually produce a negative reaction. Why? Because if the company surprises but then downgrades their future earnings potential, they effectively removed a good portion of the hope generated from the surprise. Stocks will often trade lower as the future outlook will likely be weaker than expected.

Remember, the market is forward looking.

Lastly, some surprises aren't really surprises at all. Some 'surprises' are anticipated by the market, either because a company has a history of continuously beating their estimates or the stock has already priced in a 'surprise' by running up or going down prior to the announcement. Therefore, the 'surprise' in that direction really wasn't a surprise at all. That's where you'll sometimes see an opposite reaction to an earnings surprise – a buy the rumor sell the fact type event.

So while predicting which companies will surprise or not (and what the surprise is comprised of) is a difficult game – the benefit of an earnings surprise will typically last for one to three months after a surprise is reported.

Coupled with the fact that companies that surprise have a tendency to surprise again in the future, this makes buying after an earnings surprise a profitable trading strategy.

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