decoding earnings upgrade a guide to identify winning stocks
In today’s financial markets, where volatility feels like a constant companion, one challenge remains for investors: identifying winning stocks.
Uncertainty often clouds decision-making, and during such times, Earnings Upgrades can become a reliable guide. Think of them as the market’s 'expected' report card—a reflection of how well a company might perform in the future and deliver value to its shareholders.
Now, this raises two key questions for investors:
Let’s explore these questions and discover how Earnings Upgrades can help shape a winning investment strategy.
To understand the importance of Earnings Estimates, let’s look at a real example.
In September 2024, Moneycontrol released a report highlighting the weakening Earnings Upgrade Momentum. It revealed that the Earnings Upgrade/Downgrade ratio had dropped to its lowest since Q1FY21. Analysts had also lowered their EPS estimates, predicting weaker results for FY25.
But reports alone won’t give us a clear picture. Let’s look at the Nifty 50 chart and see what it says.
The Nifty 50 chart reflected this trend, showing a short-lived rally followed by a correction. While several factors contributed to this decline — such as FII selling, a global economic slowdown, and the geopolitical tensions in the Middle East — the report strongly supports the need for a solid exit strategy.
But before we make any concrete opinions let’s understand the metric a little more.
They are forward-looking projections for a company’s earnings per share (EPS). Analysts regularly update these estimates based on new information like quarterly results, industry news, or regulatory changes.
Generally, stocks with upward EPS revisions tend to outperform because these upgrades indicate growing confidence in a company’s future performance.
At sharpely, we track earnings revisions using a metric called Earnings Upgrade (3M).
This is calculated by comparing the current EPS NTM (next twelve months) estimate to what it was three months ago. It gives investors a clear view of changing expectations and helps identify potential opportunities.
Now, to answer our first question — Is earnings upgrade a good indicator? — we need concrete proof. And to get that we conducted a backtest using our earnings upgrade metric.
Here’s how we approach it: Our hypothesis is simple — stocks that have experienced a strong earnings upgrade over the past three months represent better buying opportunities than those that haven’t.
If this sounds like a lengthy experiment, don’t worry. In sharpely, this can be done in just a few clicks. Let us show you how.
We have a powerful tool called ‘Metric Performance’ that lets you backtest 400+ metrics across different timeframes in the major indices.
(We have shared an image above for your understanding.)
Once you click ‘Run’, stocks are sorted in ascending order and grouped into five portfolios based on percentiles. Each portfolio is called Quintile.
For example, Quintile 1 includes stocks in the 0–20 percentile range, while Quintile 5 includes those in the 80–100 percentile range. Each stock within a portfolio is given an equal weight. These portfolios are then rebalanced with new stocks, ensuring the portfolios remain up-to-date with the latest market trends and stock performance.
[Note: In our case, the Quintile 5 portfolio is the one that contains stocks with the highest EPS upgrades in the last 3 months. Quintile 1 portfolio, on the other hand, contains stocks with the lowest EPS upgrades (and even downgrades) in the last 3 months.]
Let’s see the results.
A whopping 78.35% 3-year return of Quintile 1 against 22.97% of Quintile 5. To get a deeper insight into the metric we will also compare it over a longer time horizon. (More than 10 years.)
Can you believe it? A massive return of 682.44% (Quintile 1) as compared to the stocks with the lowest earnings upgrades (Quintile 5) that generated just 226.52%.
These numbers prove that 'Earnings upgrade' is a powerful signal for identifying outperforming stocks. However, it’s not going to matter much if we can’t filter out such stocks amidst all the buzz.
So, in sharpely, we have a trick to do that as well. Less of a trick, and more of another powerful tool. It’s called the Advance Screen Builder. It lets you screen stocks based on the parameters you set.
Let’s not waste any time and immediately get into it.
Let us give you a quick intro to the builder and then we will move on to the process of finding the stocks. For those new to building screens, sharpely provides a detailed knowledge base to guide you through the process here.
You can select Universe across Index, Exchange, or create a custom universe. You can select the Candle timeframe (1 Day, 1 Week, or 1 Month) and then you start adding conditions. You can also select when you want the said condition to be true (now or in the past.)
Here are the conditions used. We have kept the condition to be true 63 days ago. Because we want to look at stocks that have an Earnings Revision of more than 5% (3 months before today).
And then when we invest in such stocks today (that have posted strong earnings estimates) we will see what happens to our portfolio. (with sharpely’s backtest feature.)
Along with this, we have also filtered out stocks with a high PE ratio to avoid expensive valuation-based stocks. Once we hit Run & click on Backtest, here’s an image to show you how the screen has faired.
It beats the Benchmark by more than 2X! Crazy, right?
In conclusion, our analysis shows that earnings upgrades can serve as a strong leading indicator for stock performance. We also showed how you can filter interesting stocks using this metric. The only limitation here is that this metric will limit your stock universe to companies with analyst coverage. So, many small and midcap stocks with no analyst coverage won't feature if you use this metric in your screener.
On the other hand, as most of the companies will be on the larger side (market-cap-wise), you can take concentrated bets if the odds seem in your favour.
What’s your take on earnings upgrades as a signal? Let us know in the comments.
