Does it make sense to buy cheap stocks with potential for improvement, or companies with a bullish earnings trend, which can be more expensive?
“Based on my experience, and backed up by market data, it can be smart to buy stocks of companies with improving earnings expectations, even if their stock prices are moving higher—provided you’re not overpaying,” says Jean Park, portfolio manager of Fidelity® Growth Strategies Fund (FDEGX).
Park and a team of Fidelity analysts recently examined the returns of stocks in the S&P 500® Index for the 30, 60, and 90 days following the end of each calendar quarter going back to 2011.
What they found, Park says, is that stocks with the most negative estimate revisions tended to underperform in each time frame. Moreover, the “losers” tended to keep losing to a larger degree from day 61 to day 90. Conversely, stocks with positive earnings revisions generally outperformed in each time period, and the degree of outperformance tended to continue from day 61 to day 90.
“As a result, buying the top decile of stocks with positive estimate changes has tended to create value over time,” Park says. “So I think it may be OK to buy stocks that are moving higher, provided fundamentals are improving and valuations aren’t out of sync.”
While Park employs a holistic management approach, she says rising earnings estimates contributed to her decision to add to selected holdings, such as Cadence Design Systems (CDNS), during the spring. It remains a notable fund holding as of August 31. In April, the chip designer disappointed with second-quarter guidance, but management affirmed its revenue target for the full year and continued to see strong design activity. Conversely, Park avoided many companies with declining earnings estimates, even if their stock values looked compelling.
“I don’t see this as a foolproof plan and there are many other factors to consider, of course, but it has helped my decision-making,” Park says.
Fidelity® Growth Strategies Fund (FDEGX) held securities mentioned in this article as of its most recent holdings disclosure. For specific fund information such as standard performance and holdings, please go to the fund ticker symbol link on this page.
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