Quantified Alpha Research

INTRODUCTION

Based on its earnings history and its inconsistent track record versus analyst estimates, Urban Outfitters (NASDAQ:URBN) will likely beat the $0.49 consensus EPS estimate and miss the $883.83 million consensus revenue estimate.

We'll start by providing our projections, proceed to an explanation of the rationale behind the projections, and finish with some additional analysis and supplementary charts. Our track record of past quarterly earnings predictions made by the model can be found here.

EPS PROJECTIONS

On average, sell-side analysts on Wall Street expect URBN to report $0.49 in EPS for this quarter. Our model projects a 55-65% probability that URBN will beat these projections. It expects a small beat on estimates, ranging from 0% to 5% higher than consensus (EPS between $0.49 to $0.52).

REVENUE PROJECTIONS

On average, sell-side analysts on Wall Street expect URBN to report revenues of $883.83 million for this quarter. Our model projects a 45-55% probability that URBN will beat these projections. It expects a small beat on estimates, ranging from 0-5% higher than consensus (revenue between $884M to $925M).

RATIONALE

Our model is predicated on the fact that analyst estimates are consistently too conservative as companies beat earnings estimates over 60% of the time. There are a number of reasons why this may be happening, but the primary cause is a number of conflicts of interest between the businesses that the sell-side analysts work for and the businesses that they cover. That said, we've found a number of companies that seemingly never miss estimates. Urban Outfitters is not one of these businesses.

URBN missed EPS projections last quarter by 16.67%, and year-over-year (YoY) earnings growth was negative 3.85%, leading to a 15% drop in its share price in just one trading session following the release. The miss marked the 4th in the last 5 quarters and their 5th in the last 10. This track record isn't strong enough to predict a miss on EPS estimates, but it does lead to a loss of confidence when predicting an upcoming beat. The story holds on the revenue side:

Urban's 2.83% revenue miss last quarter was their 3rd in the last 5 quarters and their 6th in the last 10. It did represent strong YoY revenue growth to the tune of 7.68%, but analysts were clearly expecting more. Urban's revenue beat history is more sporadic than their EPS beat history, and is more in line with their one-day price performance. In fact, over the last 6 quarters, both times that URBN beat revenue expectations their price rose, and the 4 times that they missed their price fell.

Another reason that we anticipate relatively weak earnings is that the market is clearly anticipating bad news. On Friday, there was a spike in volume for the $32 strike put option contracts expiring on August 21st. These short-term puts are clearly a play on earnings (they expire within 5 days of the earnings call), and represent 776,300 underlying shares, or over half of URBN's average daily trading volume. At $32, the strike is 7.73% out of the money, which is actually inline with URBN's earnings day volatility average over the last 6 quarters of 8.45%.

Another indicator of poor market expectations is the price performance of the stock heading into earnings. Below is a look at some of the inputs to our technical analysis model that shows how Urban Outfitter's current price compares to its recent moving averages:

URBN is trading at prices well below its simple moving averages for all 3 time-horizons, 20, 50, and 200 days. The stock is down 8.32% in the last 20 trading sessions, and is 31.60% below its 52 week high. Add in a short float nearing 10% and it's clear that the market isn't anticipating further good news from Urban Outfitters.

CONCLUSION

With an inconsistent earnings day track record, weak short-term price performance, and a huge short float, we don't anticipate much good news from Urban Outfitters this afternoon. Add in that options-traders are betting heavily against Urban Outfitters this week and the stage is set for another earnings-day price drop for the company. That said, with the market expecting such bad news, it's worth considering the potentially profitable contrarian play.

With analysts expecting EPS of $0.49, they are effectively predicting 0% YoY EPS growth (URBN reported $0.49 EPS 4 quarters ago.) This prediction is actually rather high considering that over the past 6 quarters, URBN has been averaging YoY EPS growth to the tune of -7.49%. With analysts expecting $883.83M revenue, they are effectively predicting 8.94% YoY revenue growth. This is also rather high when compared to their average YoY revenue growth from the past 6 quarters of 7.17%. In fact, over the past 6 quarters, URBN has only experienced YoY revenue growth of 8.94% or higher once.

Summary

JC Penney has an inconsistent earnings day history, beating less than 50% of EPS and revenue estimates over the last 12 quarters.

The stock has one of the highest short floats in the entire market and has negative short-term price performance, indicating that the market is anticipating bad news.

JCP has moved an average of 11.18% in the trading session following an earnings release over the last 6 quarters, with downward moves after each of the last 4.

With the market anticipating bad news, the upside of a beat outweighs the downside of a miss. Over the last 6 quarters, upside swings were 21% vs downside of 6.28%.

Introduction

Our quantitative earnings model predicts that JC Penney (NYSE:JCP) will report EPS that will exceed current analyst expectations and revenues that will miss. The company is expected to release earnings before market open on Friday.

We'll start by providing our projections, proceed to an explanation of the rationale behind the projections, and finish with some additional analysis and supplementary charts. Our track record of past quarterly earnings predictions made by the model can be found here.

EPS Projections

On average, sell-side analysts on Wall Street expect JC Penney to report -$0.50 in EPS for this quarter. Our model projects a 55-65% probability that JC Penney will beat these projections. It expects a small beat on estimates, ranging from 0-5% higher than consensus (EPS between -$0.49 to -$0.46).

Revenue Projections

On average, sell-side analysts on Wall Street expect JC Penney to report sales of $2.86 billion for this quarter. Our model projects only a 45-55% probability that JCP will beat these projections, predicting a miss on estimates.

Rationale

Our model is predicated on the fact that analyst estimates are consistently too conservative as companies beat earnings estimates over 60% of the time. There are a number of reasons why this may be happening, but the primary cause is a number of conflicts of interest between the businesses that the sell-side analysts work for and the businesses that they cover. That said, we've found a number of companies that seemingly never miss estimates. JC Penney is not one of these businesses.

JCPenney beat EPS last quarter by a very strong 27.85%, marking it's 6th beat in the last 10 quarters. The miss that was recorded the previous quarter marked the end of 5 straight quarters of EPS beats. Before that streak though was a streak of 5 straight misses. JC Penney doesn't appear to be getting any favors from sell-side analysts. The story is the same on the revenue side:

JCP missed last quarter by 0.58%, marking its 6th miss in the last 10 quarters. A look at their revenue beat size history (top chart) shows that when they do miss, it tends to be by a larger margin then when they beat. JCP's weak revenue performance versus estimates is partly why we anticipate an upcoming revenue miss. Another reason is the short-term price performance of the stock. Below is a look at some of the inputs to our technical analysis model that shows how JC Penney's current price compares to its recent moving averages:

JC Penney is trading well below its 20 and 50 day simple moving averages heading into earnings, which is a warning sign that the market is anticipating poor earnings results. The company has lost 8% of its market cap over just the last 20 trading sessions and is over 25% below its 52-week high. Another warning sign that the market is anticipating bad news is the huge short activity on the stock. For scale, the table below shows JC Penney's short interest compared to the 5 stocks in its group (multiline retail) with the lowest short floats:

JCP's short float of 32.83% implies that nearly one third of the company's outstanding shares are sold short. This is a huge number that ranks JCP's short interest in the bottom 20 of the +3200 stocks that we cover. Granted, the multiline retail group averages a much higher (6.87%) short float than the market (3.56%), but even still, JC Penney's is the highest in the group.

Conclusion

With a huge short float, poor short-term price performance, and an inconsistent earnings history relative to expectations, we anticipate a rather poor earnings report from JC Penney. That said, we also feel that given that the market appears to agree with us, there is likely little to be gained from going short on JCP ahead of earnings and there may be significant upside should they surprise and beat expectations. Over the last 6 quarters, the company has been steadily growing its EPS and revenue, and analysts are clearly expecting this trend to continue.

Should JCP match analyst EPS estimates of -$0.50, they would have grown EPS by 33% year-over-year. Should they match revenue estimates of $2.86B, they would have grown revenue by 2% year-over-year. These growth rates are impressive, but likely won't be enough to buoy the stock upwards given its recent performance. The company will likely need to beat these expectations to produce gains for investors. While we anticipate a relatively poor earnings report from JC Penney relative to analyst expectations, we feel that the risk-reward nature of the stock's price performance and short-interest warrant further upside on a short-term uptrend should they happen to beat than downward pressure should they miss.

(The following article was written by Quantified Alpha contributing analyst Clement Kwong, CFA level 3 candidate.)

Introduction

Fifth Third Bancorp (NASDAQ:FITB) is one of America's biggest bank holding companies, with a market cap of $17.1 billion and over $142 billion in assets. With over 1,300 full service locations, it operates in four business segments: Investment Advisors, Branch Banking, Consumer Financing, and Commercial Banking.

FITB released Q2 earnings in late July, with some mixed results. Earnings of $0.36 only met estimates, while revenue of $1.45 billion missed by $20 million. However, the company saw its net interest income of $892 million increase 5% from Q1, accounting for almost 60% of revenue. FITB's earnings can be attributed to its cost-saving plan announced in June. The cost of selling and consolidating over 100 branches led to $97 million in non-cash impairment charges, higher than the $75-85 million expected. We believe this is an undervalued stock with solid price momentum and positive investor sentiment, making it one of the more attractive stocks in the financial sector. Combined with a more favorable interest rate environment, we expect FITB to outperform the market in the next 12 months.

Value Overview

Taking a quantitative approach, our analysis looks at certain metrics that have a strong predictive ability. Historical backtesting has shown that companies that rank in the top of these metrics have, on average, produced excess risk-adjusted returns relative to the market.

Our model output shows that FITB is quite cheap relative to the market and its sector. On an earnings basis, it is quite attractive, with a yield of 8.14%. This implies a multiple of around 12X earnings, much lower than the market and sector median of 26X and 16X, respectively. FITB's earnings yield ranks the company in the 86th percentile of the market. Historical backtesting has shown that stocks ranked between the 80th and 89th percentile of the market have an average excess returns of 4.06% per year. Their price-to-book ratio of 1.07 offers a nice cushion for risk-averse value investors. Although sales yield is on the low side, it is right in line with the sector's median. Along with a solid free cash flow and dividend yield that has returned over $38 million this year, FITB offers investors an undervalued stock in an outperforming sector.

Growth Overview

FITB has shown solid price momentum over the last year, gaining over 10% during that time and nearly 14% in the last 6 months. The company's 6-month performance puts it in the 75th percentile of the market. Historical backtesting has shown that stocks ranked between the 70th and 79th percentile in 6-month price performance have produced an average excess return of 1.37%. Considering the stock still looks quite undervalued after a 14% price appreciation in the last 6 months, we feel FITB has further upside in the next twelve months. The company's weak earnings growth and return on assets can be attributed to its cost savings plan as it looks to improve efficiency, competitiveness, and the quality of customers' experience. We expect the benefits of the cost savings plan to be realized down the road as the company puts itself in a position to generate solid returns in a favorable environment. With interest rates expected to increase in September or December, banks should benefit from a wider interest rate spread (difference between the cost of capital to banks and the cost of capital offered by banks). Considering net interest income accounts for over 60% of FITB's revenue, we expect earnings to start growing at a reasonable rate.

Sentiment Overview

Investor sentiment for FITB has been quite positive, driven primarily by the short interest ratio. Its short ratio of 1.27% is one of the market's lowest, ranking the company in the 86th percentile. Historical backtesting has shown that stocks ranked between the 80th and 89th percentile in interest short ratio have produced an average excess return of 3.35% per year. The low level of short interest indicates that short sellers have a low confidence level betting against FITB. We believe the activity of short sellers to be highly predictive of future returns, due to the fact that short sellers are typically more sophisticated than the average retail investor.

Outlook

Given the attractiveness of FITB's fundamentals, solid pricing momentum, as well as the positive investor sentiment, we believe the stock will outperform the market in the next twelve months. We also like management's effort to cut costs and strengthen the company's balance sheet as they position themselves for a more favorable interest rate environment. Their plan to close approximately 105 branches shows their commitment to reduce expenses, while hopefully improving the quality of customer service and product deliveries. For the remainder of 2015, we will look for FITB to continue growing its net interest income. With higher rates in site, a widening of interest rate spread should lead to higher profits for the bank's primary line of business.

A) Introduction

While JPMorgan Chase and Co. (NYSE:JPM) continues to be hit by litigation issues, the stock price keeps making new highs. Similar to our recent report on Citigroup (NYSE:C), we believe there is massive upside in JPMorgan. US banks are extremely well capitalized at this point, and are expected to benefit as interest rates rise in the coming months.

Quantitatively, JPM possesses many of the factors of stocks that have historically outperformed the market. The stock trades at a cheap valuation, has strong price momentum, and is loved by the 'smart money' on the street. Each of these indicators has historically been a strong signal of future outperformance.

We'll remind investors that we are quants who sift through academic papers and historical data to find repeatable patterns that can be exploited for profit. We've distilled our insights into an equity-pricing model that seeks to use historical back testing to generate 12-month price targets that are more accurate than the Wall Street consensus.

B) Value

We take a quantitative approach to investing, preferring to focus our analysis on a certain set of metrics that have a strong predictive ability. We'll start by analyzing JPM's value profile. This is important to look at as "Value stocks have higher average returns than growth stocks". JPM's valuation profile is shown below:

JPM is a relatively cheap stock. The company is especially cheap from an earnings basis, with its 8.97% earnings yield ranking in the 89th percentile of all stocks in the market. Historical back testing shows that stocks ranked within the 80th to 89th percentile of the market by earnings yield have historically beaten the market by 4.06% a year, on average:

JPM is also pretty cheap from a book value basis. Its 1.05x price to book multiple is ranked in the 84th percentile of the market.

Stocks ranked in the 80th to 89th percentile of the market based on price to book value have historically outperformed the market by 2.69% a year on average:

The market has consistently rewarded investors of cheap stocks with significant alpha. This is because cheap stocks are either embarrassing to hold or are part of boring industries with little "excitement".

JPM fits into the former category, as the major US banks have been embarrassing (some might say scary) to hold since the GFC. This is especially true with JPM, as they have been getting hit with hundreds of lawsuits. Over time, this inefficiency will correct itself as it always does and investors should expect JPM to be a major beneficiary. This is even more so now that interest rates are expected to rise in the upcoming months.

Our algorithms project JPM's cheap valuation to contribute 3.05% of alpha moving forward, based on how companies with similarly cheap valuations have historically outperformed. This puts it in the 75th percentile of all stocks based on value.

C) Momentum, Growth, and Profitability

There are a variety of different growth metrics that have been shown to predict stock returns. Most important among them is price momentum. Winning stocks keep winning, and losing stocks tend to keep losing. JPM's growth profile is shown below:

JPM has recently been gathering momentum. Its stock price has gained 21.8% over the last twelve months, and 24.6% over the last six. The company is also seeing huge bottom-line growth. Earnings have grown 40.7% over the last four quarters, relative to the same period a year ago. Profitability is solid, with a return on equity of 10.65% and return on assets of 0.90%.

Our algorithms project JPM's solid momentum and profitability profile to contribute 2.45% of alpha moving forward, based on how companies with similarly strong growth have historically outperformed. This puts it in the 76th percentile of all stocks based on growth.

D) "Smart Money" Sentiment

In addition to value and momentum, we will also analyze how the "smart money" on the street is playing JPM. We have found loads of academic research showing that short sellers, company insiders, and institutions all predict stock returns. This breakdown is shown below:

The key thing in the table above is the extremely low short interest ratio, which shows that only 1.08% of JPM's total float is currently shorted. Why is this important? Short sellers are much more informed investors than the average market participant. When a stock has an extremely low short interest ratio, this means that the short sellers don't see any significant downside in the stock.

Historical back testing shows that stocks ranked within the 80th to 89th percentile of the market by short interest ratio have historically beaten the market by 3.35% a year, on average:

Overall, our algorithms project JPM's sentiment profile to contribute 3.22% of alpha moving forward, based on how companies with similar levels of sentiment have historically outperformed. This puts it in the 81st percentile of all stocks based on sentiment.

E) Conclusions

This brings us to our projected 12-month price targets. Our equity pricing model use historical back testing to predict the amount of "excess returns" (i.e alpha) a stock will generate. It combines this with the stock's beta to project a base case target price, as well as a range of potential prices. This range is expected to have a 75% area of accuracy (i.e. the stock price has a 75% probability of being within the range in 12 months). These projections are shown below:

In our base case, the Quantified Alpha algorithms expect JPM to rise from its current price of $68.25 to $81.59 over the next twelve months (representing a gain of +20%). We project a 75% probability that JPM's stock price will be between $61.48 to $102.93 in 12 months. We're far more optimistic than Wall Street analysts, who currently have an average 12-month price target of $74.57 (representing upside of 9% from current prices).

Investors looking to maximize return while minimizing risk should look to JPM's call options. In particular, the $65 strike, January 15th 2016 calls can be bought for $5 right now. This means investors just need JPM's stock price to get to $70 (a gain of 2.6%) within 8 months to break even on the calls.

A) Introduction

AerCap Holdings N.V. (NYSE:AER) is one of the largest aircraft leasing companies in the world, engaging in the leasing, financing, sale, and management of commercial aircraft and engines. It has a market cap of $9.2 billion, and employs over 300 people. AerCap is a remarkably rare stock from a quantitative perspective. It shows strength in every factor that quantitative researchers and academics have found to have predictive value. It combines a cheap valuation, with strong price performance, profitability, earnings momentum, and 'smart money' sentiment. Our models have identified AerCap as one of the most attractive investment opportunities in the entire market. Investors would be wise to heed the lessons from history. Expect AerCap to strongly outperform the overall stock market over the next 12 months.

We'll remind investors that we are quants who sift through academic papers and historical data to find repeatable patterns that can be exploited for profit. We've distilled our insights into an equity-pricing model that seeks to use historical back testing to generate 12-month price targets that are more accurate than the Wall Street consensus.

B) Value

The strongest argument for buying AerCap is the stock's extremely cheap relative valuation. Relatively cheap stocks have historically outperformedexpensive stocks by a wide margin. It is the most important predictive indicator available. The following table shows how AerCap ranks within the market on five different value metrics:

Within valuation metrics, earnings yield and free cash flow yield have historically had the highest correlation with future returns (i.e the best predictive power). AerCap's 11.8% earnings yield and 65% free cash flow yield are both ranked in the 94th percentile of all stocks in the market, which means it's higher than 94% of stocks. Historical back testing shows that stocks with an earnings yield ranked in the 90-99th percentile of the market generate annual excess returns of 5.40% on average:

Similarly, stocks with a free cash flow yield ranked in the 90-99th percentile of the market have historically generated average annual excess returns of 5.33%:

It's clear that history favors AerCap's position right now, as the market has consistently rewarded investors of cheap stocks with significant alpha. This is because cheap stocks are either embarrassing to hold or are part of boring industries with little "excitement". AerCap fits into the latter category, as the aircraft leasing industry tends to fly under the radar as a relatively niche industry. Over time, this value inefficiency corrects itself and cheap stocks outperform.

Our algorithms rank AerCap's value profile in the 93rd percentile of all stocks in the market (i.e cheaper than 93% of stocks). Our algorithms expect its relative value profile to contribute 5.97% of alpha moving forward. This means that, holding everything else equal to zero, we would expect AerCap to outperform the market by 5.97% over next twelve months just based on its extremely cheap valuation.

C) Growth

Next, we'll analyze AerCap's price momentum, growth, and profitability profile. Again, we'll look to the past to see how stocks in similar situations have historically performed. The chart below ranks AerCap on five different growth metrics within the market, each of which has been shown to have predictive power:

AerCap has started to get the attention of market participants, gaining 12.1% in price over the last six months (versus a gain of 1.5% for the average stock). The company continues to be efficient, with a return on equity of 14% and a return on assets of 2.5%. This indicates the competence of company management, and their ability to deliver returns to shareholders.

The one metric that is truly impressive in the chart above is the company's 289% increase in trailing twelve-month earnings. This is a huge increase in earnings, and puts it in the 94th percentile of the market ranked on earnings growth. Historical back testing shows that stocks ranked within the 90th to 99th percentile of the market by earnings growth have historically beaten the market by 1.61% a year, on average:

Considering AerCap's extremely cheap valuation, it is quite impressive that the company is profitable and growing earnings at such a high rate. That is truly a rare combination within today's expensive market.

Our algorithms rank AerCap's growth profile in the 73rd percentile of all stocks in the market (i.e better than 73% of stocks). Our algorithms expect its relative growth profile to contribute 2.08% of alpha moving forward. This means that, holding everything else equal to zero, we would expect AerCap to outperform the market by 2.08% over next twelve months just based on its growth profile.

D) Sentiment

Next, we'll analyze AerCap's sentiment profile, looking at how the "smart money" (i.e. short sellers, institutions, and company insiders) has been recently trading the stock. These investors tend to have an informational advantage over the average market participant and their transactions often foreshadow future movements in price:

Institutional investors have been pilling into AerCap recently, increasing their ownership stake by almost 12% over the last three months. That puts the stock into the top 2% of most institutionally bought stocks this quarter, and reflects the belief of the 'smart money' that AerCap is headed higher. Historical back testing shows that stocks ranked within the 90th to 99th percentile of the market by change in institutional ownership have historically beaten the market by 2.77% a year, on average:

Company insiders have essentially maintained their positions in the stock recently, which is actually a positive sign in an environment in which company insiders are dumping stocks across the market. Short interest remains near the averages of the stock market at 4.4% of the float, reflecting mild conviction on the part of short sellers.

Our algorithms rank AerCap's sentiment profile in the 96th percentile of all stocks in the market (i.e top 4%). Our algorithms expect its sentiment profile to contribute 5.64% of alpha moving forward. This means that, holding everything else equal to zero, we would expect AerCap to outperform the market by 5.64% over next twelve months just based on the current bullishness of the 'smart money' investors.

E) Earnings Momentum

While earnings momentum is not factored into our equity-pricing model, it can be used as a good supplementary indicator of a company's performance relative to analyst expectations. Companies that have been beating analyst expectations tend to gain in price and are statistically more likely to beat expectations the following quarter. A look at AerCap's earnings history is shown below:

AerCap beat last quarter's Wall Street consensus EPS estimates by 12.5%, extending its streak of EPS beats to five quarters in a row and nine beats in the last ten quarters. AerCap also beat the consensus revenue estimates by 3.1%, which was its 4th quarter in a row that it beat revenue expectations and seventh beat in the last ten. There is a clear history of AerCap beating the expectations of sell-side analysts. This is important, as we've found through extensive historical back testing that companies that beat analyst estimates are far more likely to beat expectations the following quarter.

We've built an earnings prediction model based off these back tests that uses historical averages to assign estimate beat probabilities and expected beat sizes, and used it to accurately predict quarterly earnings. These projections are for AerCap are shown below:

Sell-side analysts currently project EPS of $1.33 and revenue of $1.28 billion for AerCap this quarter.

Our model projects a 65-75% probability that AerCap will beat these estimates, with an expected beat size of 5-10%. Our model also projects a 55-65% probability that AerCap will beat the revenue consensus, with an expected beat size of 0-5%. AerCap releases its results next Tuesday, before the market open.

F) 12-month Price Predictions

This brings us to our projected 12-month price targets. Our equity pricing model use historical back testing to predict the amount of "excess returns" (i.e alpha) a stock will generate. It combines this with the stock's beta to project a range of 12-month target prices. This range is expected to have a 75% area of accuracy (i.e. the stock price will be within the price range 75% of the time). These projections are shown below:

On our base case, the Quantified Alpha algorithms expect AerCap to rise from its current price of $46.75 to a price of $57.73 over the next twelve months. This represents upside of 23.5% from current prices.

Our algorithms project a 75% probability that AerCap's stock price will be between $44.38 to $71.74 in 12 months. This ranges from potential downside of -5.8% to potential upside of +53.5%. The current risk-reward is clearly heavily skewed to the upside.

These are slightly more optimistic projections than Wall Street analysts, who currently have an average 12-month price target of $56.64 (representing upside of 21% from current prices).

G) Conclusion

A) Introduction

Ever since Citigroup's (NYSE:C) fall from grace as the biggest bank in the world to having to be bailed out by the U.S. government, investors have been wary of the bank and its management. However, since then, Citibank has been selling off assets from Citi Holdings and is now one of the best-capitalized financial institutions in the world. Citi currently possesses many of the factors of stocks that have historically outperformed the market. The stock trades at a cheap valuation and yet has strong price momentum, which is a strong signal of future outperformance.

We'll remind investors that we are quants who sift through academic papers and historical data to find repeatable patterns that can be exploited for profit. We've distilled our insights into an equity-pricing model that seeks to use historical back testing to generate 12-month price targets that are more accurate than the Wall Street consensus.

B) Value

The strongest bull argument about Citi regards its cheap valuation. Its clear from it's relative value profile why:

Earnings yield has historically been shown to have the highest correlation to excess returns, and is thus the most relevant metric to consider when highlighting a stock's value profile. At 7.31%, Citigroup's earnings yield is nearly twice the market median of 3.89%, ranking it in the 82nd percentile of all stocks in the market (NYSE and NASDAQ). Historically, stocks with an earnings yield ranked in the 80-89th percentile of the market generate annual excess returns of 4.06%:

Citigroup is also cheap from a price-to-book standpoint, as investors can currently buy the stock for only 82% of its book value. This places it in the top decile of all stocks from a book value basis, and makes it a safe investment for conservative value investors. While not exactly a free cash flow machine, Citigroup's free cash flow yield is well above the market median of 9.33% and offers further upside. Investor's won't be buying the stock for its meager 0.34% dividend yield, but now that the government has approved a $7.8 billion share buyback program and dividend increase to $0.05 per quarter, expect more capital to be returned to shareholders.

Our algorithms rank Citi's value profile in the 85th percentile of all stocks in the market (i.e. top 15%). Our algorithms expect its relative value profile to contribute 4.50% of alpha moving forward. This means that, holding everything else equal to zero, we expect Citi to outperform the market by 4.50% over next twelve months just based on its relatively cheap valuation.

C) Growth

The financial sector is the second highest performing sector over the last 6 months, behind only Health Care, with the average stock gaining 10.45% over that period (versus the market average of 3.02%). Citigroup has been a leader during this run, with a 6-month price performance that more than doubles its sector average. Below is Citigroup's growth overview:

The strongest two aspects of Citigroup's growth profile are its 6-month price performance of 22.68% and its 29.49% 12-month earnings growth. Investor sentiment has clearly shifted on the stock since its brutal 2014 Q4 (Jan 15, 2015) earnings release. In that quarter, Citi's EPS missed Wall St. consensus estimates by over 33%. Its year-over-year EPS growth rates are positive once again, and the market has rewarded its strong earnings. Citigroup's growth profile is hindered by its weak profitability on both an ROE and ROA perspective, and while this is a viable risk, management has taken a proactive approach in reducing the size of its underperforming assets. As a result, over the last 3 quarters, Citigroup's ROA has increased each quarter, rising from 0.39% to 0.70%. Its ROE has also increased each quarter, rising from 3.64% to 6.34%. This is clearly a favorable trend that seems likely to continue.

We rank Citi's growth profile in the 59th percentile of all stocks in the market. Our algorithms expect its relative growth profile to contribute 1.04% of alpha moving forward. This means that, holding everything else equal to zero, we would expect Citi to outperform the market by 1.04% over the next twelve months just based on its solid growth.

D) Earnings Quality

While oft ignored, the quality of a company's earnings is an important and predictive measure of a stock's future success. Investors are fixated on the short-term bottom line, and thus companies are priced based on the quantity, rather than the quality of their earnings. This leads to artificially high prices for companies with very poor quality earnings, and vice versa. With that in mind, we will consider Citigroup's earnings quality:

Firstly, it's important to consider that the correlations to excess returns for earnings quality are generated at the extremes. For example, even though Citigroup's earnings accruals ratio is only ranked in the 46th percentile of the market, it is still slightly positively correlated to excess returns. Earnings accruals ratio is a measure of the "non-cash" earnings reported. While non-cash earnings are not inherently bad, to an extent, really high levels (+6%) may be indicative of management attempting to "game" earnings for short-term gain. At 0.43%, a very small percentage of Citigroup's earnings are non-cash and there is little for investors to be wary of from this standpoint.

The financing to assets ratio of -1.11% shows that Citigroup is paying back debt and buying back shares, both of which should increase future earnings per share. Finally, its depreciation to capital expenditures (CAPEX) ratio of 145% shows that Citigroup's depreciation expense was much higher than its capital expenditures. This is a good sign as management is clearly not afraid to hurt its short-term earnings (depreciation is expensed, while CAPEX is capitalized) in order to have stronger future earnings.

Our algorithms rank Citi's quality profile in the 77th percentile of all stocks in the market. Our algorithms expect its relative quality profile to contribute 3.90% of alpha moving forward. This means that, holding everything else equal to zero, we would expect Citi to outperform the market by 3.90% over the next twelve months just based on its strong earnings quality.

E) Earnings Momentum

While earnings momentum is not factored into our equity-pricing model, it can be used as a good supplementary indicator of a company's performance relative to analyst expectations. A look at Citigroup's earnings history shows a clear trend:

Citigroup has consistently underperformed Wall St. expectations for the fourth fiscal quarter (FQ4). This trend goes all the way back to 2009, when they missed by 3.03%. In fact, since that FQ4 miss in 2009, Citigroup has missed every FQ4 estimate while missing no other estimates, other than FQ3 2013. It appears that investors may not have noticed this trend and the price inevitably dips around every FQ4 report. It's also important to consider the year-over-year growth rates to try to discern company trends:

The good news is that over the past 2 quarters, EPS growth has been positive, hovering around 17%. In fact, other than the disastrous FQ4 of last year, Citigroup had been growing EPS fairly consistently. Revenue growth, on the other hand, has been consistently negative, hovering around -5%. This is a result of Citigroup becoming leaner and divesting the less efficient revenue streams, which is why EPS growth has been consistently positive. In all, it looks like Citigroup's earnings are trending positively and will likely beat its FQ3 2015 estimates (though, if history is any indication, it will likely miss its FQ4 estimates.)

F) Technical Indicators

While we'll keep this part short since Seeking Alpha is for longer-term investment ideas, it's important to consider the expected short-term price movements to determine whether now is a good time to take a position. With that said, below is Citi's technical overview:

Citi is trading well above its 20-day, 50-day, and 200-day moving averages, indicating strong short-term uptrend. This is important to watch, as academic studies have shown that stocks that trade above their moving averages tend to perform much stronger than the market over the following days and weeks. While the stock price is moderately overbought (gaining 5.6% over the last twenty days), the short-term return reversal effect only applies to illiquid stocks.

Citigroup is trading right near its 52-week highs. Again, this is a very bullish sign moving forward as stocks that trade near their highs have beenacademically proven to outperform over the subsequent months. Prospect theory states that people become risk-averse when holding profits. When a stock is at a 52-week high, the majority of investors holding the stock have a profit on the stock. This creates a strong behavioral urge to "lock in profits" for investors, leading to irrational selling pressure. Rational investors can exploit this phenomenon and generate excess returns by buying stocks when they are at 52-week high.

Overall, our short-term quantitative technical analysis model rates Citigroup's short-term outlook as "Strong". This means the stock is likely to outperform the market over the following 20 days. Keep in mind that technical analysis indicators tend to be less useful for low volatility stocks like Citigroup.

G) Qualitative Analysis

It's important to supplement quantitative analysis with a discussion of qualitative factors affecting the company. We don't advise investors to make decisions solely on the quantitative merits of a company without first considering its potential catalysts and risks. It's also important to try to create a "story" as to why a stock may be performing a certain way and how it will perform in the future. This makes it possible for you to compare your predictions to the stock's actual performance and constantly reevaluate the accuracy of your story to determine whether to stay in the position or not.

Firstly, we agree with Oakmark Fund's Bill Nygren (who manages over $16B in assets and owns 8.13 million shares of Citigroup) who states that Citi has "two hidden sources of value, neither of which is reflected in GAAP earnings: a deferred tax asset and a larger base of excess capital that is growing at a rapid rate." He says that these are assets that are likely undervalued by the market because of their hidden nature, and that their eventual recognition will likely lead to further price gains. We also agree with Mr. Nygren that last year's quantitative stress test confirmed that "the company has significantly more excess capital than its peers" and that this capital will eventually benefit shareholders through capital return or smart balance sheet growth. Another significant catalyst is the expected interest rate hikes (though the timing of these hikes is unknown) that should provide an earnings tailwind as the bank's net margins increase.

The risk factors to consider are further conduct and legal problems that could lead to future fines and spark investor fears. There's also the potential for further regulatory interventions such as increased liquidity requirements or higher regulatory capital demands (though Citi would be better positioned than its peers in this respect). Finally, there's the potential that interest rates take longer than expected to rise or that the global economic recovery changes course and a new depression takes place.

We feel that these risks are overblown and that potential catalysts far outweigh the risks regarding Citigroup. This qualitative analysis supports our quantitative findings.

H) Conclusions

Given its undervaluation, strong short-term momentum, earnings quality, and earnings momentum, we feel that Citigroup has an attractive quantitative profile that will outperform the market over the next 12 months.

Our equity pricing model uses historical back testing to predict the amount of "excess returns" (i.e. alpha) that a stock will generate. It combines this with the stock's beta to project a range of 12-month target prices. This range is expected to have a 75% area of accuracy (i.e. the stock price will be within the price range 75% of the time). These projections are shown below:

On our base case, the Quantified Alpha algorithms expect Citigroup to rise from its current price of $58.44 to $69.68 over the next twelve months. This represents upside of 19.23% from current prices.

Our algorithms project a 75% probability that Citigroup's stock price will be between $50.41 and $90.87 in 12 months. This ranges from potential downside of -13.75% to potential upside of +55.49%. Risk-reward looks skewed to the upside. These are more optimistic projections than Wall Street analysts, who currently have an average 12-month price target of $65.64 (representing upside of 12.32% from current prices).

We advise investors looking to take advantage of this opportunity to look at Citi's long-term options, specifically the March 20th, 2016 $55 calls. They are currently trading for $6.15, which implies a break-even price of $61.15 ($55 + $6.15). This means that investors need only a 5% move in Citi's stock price from now until March 20th (8 months) to break even. While it's generally smart to avoid buying options (75% of options expire worthless), long-dated in-the-money options are typically cheap and offer investors the benefits of leverage without the "theta burn" of short-term options.

The following article was written by Quantified Alpha contributing analyst Clement Kwong, CFA level 3 candidate.

A) Introduction

Archer Daniels Midland Co. (NYSE:ADM) is one of the world's leading agricultural processors providing feed ingredients for livestock, alternative fuels, and environmentally-friendly alternatives to traditional chemicals. With a market cap at almost $30 billion, ADM employs over 33,000 employees and more than 270 processing plants across six continents. As a global leader in vegetable proteins and fiber, ADM is well positioned to take advantage of a growing world population and a focus towards a healthier diet.

We are big believers in studying the past to figure out the patterns that can predict the future. ADM is a unique stock as it checks off many of the factors of stocks that have historically outperformed. The company trades at a relatively cheap valuation, is growing earnings at a solid rate, and is returning huge sums of capital back to shareholders through targeted buybacks. The company also has a high level of earnings quality, and is loved by the 'smart money.' ADM is poised to move higher over the next 12 months.

B) Value

ADM is significantly undervalued relative to the market with a twelve-month sales yield of 265% and a free cash flow yield of 20%. Both measures are well above the median stock in the market, representing a heavy relative discount. ADM's 8.42% earnings yield is also almost double the earnings yield of the median stock in the market. ADM also continues to provide returns to shareholders, returning over $0.7 billion through dividends and the repurchase of 12 million shares in the first quarter of 2015. Overall, we feel that ADM's cheap valuation will be a major driver of outperformance moving forward:

C) Growth

ADM has seen its share price fall almost 10% since April as several analysts downgraded ADM from a buy to a hold. We believe this downturn presents a great entry point for value investors to start taking a look. With that being said, ADM's stock price performance has still been relatively solid over the last six (+2.85%) and twelve-month periods (+4.45%). Earnings have also grown 83% over the last twelve months, while profitability remains very strong. Overall, we expect growth to be a mild driver of outperformance over the next twelve months:

D) Sentiment

The 'smart money' continues to remain bullish on ADM, even as it fell 10% the last few months. This is reflected by the very low short interest ratio (1.38% of float is shorted). The low short ratio indicates the low level of confidence that short sellers have in betting against ADM. It is also notable that company insiders have essentially maintained their position in ADM, even while most stocks in the market have seen heavy selling. Institutional investors maintained their positions during the correction as well. Overall, we expect sentiment to be a major driver of excess returns moving forward. When the 'smart money' has little conviction in a stock's downside, that is typically a very good sign.

E) Earnings Quality

ADM exhibits strong earnings quality, indicating they are more than likely to maintain growth. Earnings accruals is calculated by taking the difference between net income and operating cash flow and dividing by total assets. This ratio of -0.98% is fairly in line with the market and a little bit better than the group median, implying that the company is not manipulating earnings. The financing to assets ratio is calculated by summing ADM's net equity and debt financing and dividing by average total assets. The large negative value is a result of ADM's strong buyback activity, which is a great sign for future returns.

ADM has also been very conservative in CAPEX spending, with its depreciation to CAPEX ratio equaling 160%. This implies that the company has been under-investing, which funny enough, is also a great sign of future outperformance. Along with their commitment to consistently grow their dividends, we believe ADM will continue to provide value for shareholders.

Outlook

Given the company's solid fundamentals and positive sentiment, we believe ADM is poised to outperform in the months to come. Although the demand of agricultural commodities has been stagnant in the last couple of years causing margins to decrease, this presents an opportunity where consolidations of struggling companies will occur and the stronger companies will survive. ADM is well positioned to take advantage of struggling competitors as well as acquisition opportunities due to its size and reach. The acquisition of WILD Flavors in 2014 reflects the company's desire to increase returns and reduce earnings volatility as it grows their new line of specialty ingredient offerings.

This brings us to our projected 12-month price targets. Our equity pricing model use historical back testing to predict the amount of "excess returns" (i.e. alpha) a stock will generate. It combines this with the stock's beta to project a base case target price, as well as a range of potential prices. This range is expected to have a 75% area of accuracy (i.e. the stock price has a 75% probability of being within the range in 12 months). These projections are shown below:

In our base case, the Quantified Alpha algorithms expect ADM to rise from its current price of $48.41 to $60.74 over the next twelve months (representing a gain of +25%). We project a 75% probability that ADM's stock price will be between $51.13 to $69.25 in 12 months. We're far more optimistic than Wall Street analysts, who currently have an average 12-month price target of $51.91 (representing upside of 7% from current prices).

A) Introduction

It's been exactly six months since the publication of our article that rated Marathon Petroleum Corp. (NYSE:MPC) as a strong investment opportunity and the best stock to buy in the energy refiner space. It's now time to review the results since the initial thesis, and determine whether Marathon is still the best refiner moving forward.

B) Quick Review of Initial Thesis

In our initial article, we compared Marathon Petroleum to Valero Energy Corporation (NYSE:VLO) and Tesoro Corporation (NYSE:TSO) on a variety of different metrics. We determined that both Marathon and Valero were attractive investments, but gave a small edge to Marathon, based on its stronger rates of profitability and lack of company insider selling. Marathon also had a lower level of short interest, and had been experiencing strong price momentum, both of which are typically signs of future outperformance.

C) Since Publication

Our initial article was published on January 30th, when Marathon was trading at $45.25. The stock closed this Friday at $54.67, representing a gain of 18.2%.

All three energy refiners listed in our article have outperformed the overall market by a wide margin since, gaining an average of 22.3%. Marathon was actually worst performer of the group, gaining 18.2% since publication, versus +21% for Tesoro and +28% for Valero.

Our perspective on the broad industry trends that are propelling energy refiners higher remain the same from our initial article. Low crude prices generally help refiners, as gas prices charged at the pump tend to remain "sticky". This means that energy refiners get to buy crude (their main input) at cheap prices, while selling gas at relatively the same prices as before (leading to an increase in profit margins). This has largely played out, with both Valero and Marathon experiencing widening margins. Expect that trend to continue as long as crude price remains depressed.

D) Thesis Moving Forward

To determine which refiner is the most attractive opportunity moving forward, we'll be analyzing the valuation, profitability, and momentum profiles of Valero and Marathon. We'll start by comparing each stock using five different value metrics to determine which one is cheaper:

Marathon and Valero are extremely cheap on a sales and earnings basis. Both have sales yields near 300%, meaning that their annual sales are three times larger than their current market cap. Valero sports an 14% earnings yield, which is almost four times the current market average.

Valero is the higher-yielding of the two, with a dividend yield of 2.44%, versus 1.83% for Marathon. Valero is also cheaper on a book value basis, with its P/B multiple of 1.57x, versus 2.48x for Marathon. Lastly, Valero is cheaper on a free cash flow basis, with an FCF yield of 23%, versus 17% for Marathon.

On average, relatively cheap stocks have historically generated excess returns over relatively expensive stocks. Our algorithms expect that value premium (i.e., value alpha) to be 5.72% for Marathon and 7.76% for Valero. Both stocks are still quite cheap relative to the market, but Valero is the cheaper of the two.

Advantage: Valero Energy

Next, we'll analyze the growth of both companies, concentrating on price momentum, earnings growth, and profitability:

Marathon and Valero have been strong performers recently. Marathon's stock price has gained 19% over the last six months and 34% over the last twelve. Valero's performance has been similar, having gained 26% over the last six months and 32% over the last twelve.

Marathon has seen the bigger increase in earnings, though, with trailing twelve-month earnings 72% higher than earnings during the same period a year ago. Valero's earnings have grown 52%. Marathon is also slightly more profitable, returning 28% on equity and 11% on assets, while Valero returned 22% and 13%, respectively.

On average, stocks that have excellent price momentum and/or strong profitability typically generate significant excess returns over the market. Our algorithms expect that growth premium (i.e., growth alpha) to be 4.78% for Marathon and 4.49% for Valero.

Advantage: Marathon Petroleum

Next, we'll analyze the companies' business quality, concentrating on their level of earnings accruals, external financing, and CAPEX:

We'll spend less time on business quality, as we don't expect to see it materially impact returns moving forward, and the companies' stats are pretty much identical. The key thing to note is the -5% change in external financing for Valero. This metric measures cash in/outflows from debt or equity. The negative number represents Valero's heavy share buyback plan and relatively neutral cash inflows from debt over the last twelve months. Companies that pay down debt and/or buy back shares have historically outperformed those that are heavily indebted and issue secondary offerings. Marathon also has a share buyback plan, but has relied on debt for cash flow (especially in Q3 2014).

Advantage: Valero Energy

E) Conclusions

Overall, we feel that Valero is the better pick within the refiner space, as it trades at a much cheaper valuation, has a higher dividend yield, and has actually had net cash outflows from debt and equity over the last twelve months. Marathon isn't a bad pick either, but we wouldn't recommend it as an investment opportunity at this point.

This brings us to our projected 12-month price targets. Our equity pricing model use historical backtesting to predict the amount of "excess returns" (i.e., alpha) a stock will generate. It combines this with the stock's beta to project a range of 12-month target prices. This range is expected to have a 75% area of accuracy (i.e., the stock price will be within the price range 75% of the time).

These projections are shown below for Valero Energy:

In our base case, the Quantified Alpha algorithms expect Valero to rise from its current price of $64.43 to $73.65 over the next twelve months (representing a gain of 14.3%). Our algorithms project a 75% probability that the company's stock price will be between $50.98 to $99.04 in 12 months. This wide range in possibilities reflects Valero's high beta, which measures market risk. Our projections are right in line with Wall Street analysts, who currently have an average 12-month price target of $76.21.

Summary

Ballard Power Systems Inc. is down over 38% since our initial bear thesis that was published three months ago, on April 20th.

We review our initial thesis and what has happened in the three months since publication with Ballard Power Systems Inc.

We look to the future, and evaluate whether Ballard is a strong short candidate moving forward.

A) Introduction

It's been three months since the publication of our initial bear thesis on Ballard Power Systems Inc. (NASDAQ:BLDP), and its time to review the risk-reward nature of the position now that the stock has fallen over 38% and hit new 52-week lows:

B) Quick Review of Initial Thesis

The core thesis of the initial article rested on the fact that Ballard sports an extremely expensive relative valuation while remaining unprofitable and dependent on external financing for survival. The company's quarterly earnings releases had consistently been a disaster as well, with three straight misses on analyst consensus EPS estimates and two straight topline misses. Lastly, 'smart money' investors (i.e. institutional investors and short sellers) had been dumping stock. Overall, we concluded that the company was likely to underperform the overall market by 24.3% over the following 12 months. Recommended it as a strong short candidate.

C) Since Publication

On June 8th, Ballard's stock price briefly gapped up to $2.50 after Ballard announced a $10 million deal to deploy their technology in 33 buses in China. The euphoria surrounding the deal faded quickly as the stock price drifted lower in the weeks afterward before falling more than 30% after the company announced a secondary offering. The offering was for 8,125,000 million common shares at a price of $1.60. This offering price was more than 20% below the stock price at announcement time, and the dilution accordingly led to a steep fall in stock price.

D) Thesis Moving Forward

Moving forward, we still see significant downside in Ballard's stock price due to the same worries expressed in the previous report. First off, the company still has an extremely expensive relative valuation even though it has fallen over 40% in price. This is illustrated in the analytical table below, which ranks Ballard on five important valuation metrics relative to the market. Some may question using the market as a relative benchmark, but it's crucial to do so to avoid industry group bias. That bias can result in justifying the valuation of an expensive stock based on the frothiness of its peer competitors.

With trailing twelve-month (TTM) sales of $64 million and a market cap of $186 million, Ballard currently sports a sales yield of 34.4%. This is well below the median sales yield of 56% and puts it in the bottom third of the market. Ballard's earnings yield is even grimmer at -10.15%, representing a TTM net income loss of $18.7 million. At the very least, the collapse in stock price has made Ballard's valuation relatively tolerable from a book value basis.

The same can't be said for Ballard's horrible free cash flow (FCF) yield of -8%, which is even worse than its previous FCF yield of -6% three months ago. This drop in FCF yield reflects the accelerating deterioration in Ballard's cash flow. Historical back testing shows that stocks ranked in the bottom 10% of the market by FCF yield have historically underperformed by over 5% a year.

On average, relatively cheap stocks have historically generated excess returnsover relatively expensive stocks. Ballard is still a relatively expensive stock, ranking in the tenth percentile of all stocks according to our proprietary ranking system. Overall, our algorithms would expect an average stock with Ballard's relative value profile to underperform the market by 7.62% a year on average.

Next, we'll analyze Ballard's growth profile, concentrating on price momentum, earnings growth, and profitability:

Ballard's price momentum remains horrible, as the stock remains in a firm downtrend. This is a bad sign for Ballard, as price momentum has historically been a strong predictive signal of future returns. The stock price has fallen 15.7% over the last six months, and 67.6% over the last twelve. During this same period, the average stock in the market gained 1.6% and 4.6%, respectively. Earnings growth remains a sore point as well, with TTM earnings 10% below earnings during the same period last year. Ballard remains extremely unprofitable, returning -20.5% on equity and -13.4% on assets. Both return rates fall right near the bottom of the market. Overall, our algorithms would expect an average stock with Ballard's relative growth profile to underperform the market by 7.62% a year on average. That puts it in the 4th percentile (bottom 4%) of the over 3,000 US listed equities our web application covers.

Next, we'll analyze Ballard's sentiment profile, concentrating on the recent activity of short sellers and institutions. Both of these are considered "smart money" investors that have an informational advantage over the average investor:

Short selling currently makes up 6.5% of Ballard's total float, which is right in line with where it was during our initial article. This puts it in the 29th percentile of all stocks in the market based on level of short interest. While some may argue that this is a bullish signal and that the stock is susceptible to a potential short squeeze, history has shown short interest to be indicative of negative future returns. Short sellers tend to be much more sophisticated than the average market participant, and when a stock is as heavily shorted as Ballard it is a sign that the 'smart money' is betting on a collapse in price. Given Ballard's historical and recent performance, it looks like the short sellers are onto something. It is also noteworthy to note the 1.76% decrease in institutional ownership, which is also right near the bottom of the market.

The few remaining institutional investors left are also selling Ballard stock. It seems the 'smart money' investors are continuing to sell the stock. Overall, our algorithms would expect an average stock with Ballard's relative sentiment profile to underperform the market by 3.91% a year on average. That puts it in the 14th percentile (bottom 14%) of the over 3,000 US listed equities our web software covers.

This brings us to our projected 12-month price targets. Our equity pricing model use historical back testing to predict the amount of "excess returns" (i.e alpha) a stock will generate. It combines this with the stock's beta to project a range of 12-month target prices. This range is expected to have a 75% area of accuracy (i.e. the stock price will be within the price range 75% of the time). These projections are shown below:

On our base case, the Quantified Alpha algorithms expect Ballard to decline from its current price of $1.33 to $1.24 over the next twelve months (representing a small decline of 6.5%). Our algorithms project a 75% probability that Ballard's stock price will be between $0.76 to $1.79 in 12 months.

These are much more sober projections than Wall Street analysts, who currently have an average 12-month price target of $2.25 (representing over 69% upside from current prices). Considering the long history of over optimistic analyst target prices, it would be wise to significantly discount their expectations.

E) Conclusion

At this point, we still think there is significant downside available in Ballard moving forward but wouldn't advise investors to short right now. The stock price is clearly in a downtrend, but it is also extremely oversold at the moment. Potential short sellers should wait till Ballard announces another big contract and gaps up in price off the news to initiate a short position. Those scenarios have historically been the best time to sell Ballard, as the stock tends to have strong, emotionally charged rallies off good news. This will significantly improve the risk-reward nature of the trade, and allow short sellers to get a better price.

A) Introduction

It's been a little bit more than six months since the publication of our initial bull thesis on Flextronics (NASDAQ:FLEX), and its time to review the position. The green arrow on the chart below shows the date of publication, and the price movement since:

B) Quick Review of Initial Thesis

In our initial report, we focused on Flextronics' extremely cheap valuation, recent company insider buying, and its strong price momentum. The company was also a free cash flow machine, and had a history of rewarding shareholders with share buybacks. Stocks that have these factors have historically generated significant alpha.

C) Since Publication

Since the article was published on January 24th, Flextronics stock price has moved from $11.04 to a high of $12.86, before falling right back to $11.02. The rise in Flextronics stock price from February to April was likely due to a post-earnings announcement drift effect stemming from the company's solid Q3 earnings release. Flextronics beat the Q3 EPS consensus by 12.5% ($0.27 versus estimates of $0.24) and beat consensus revenue estimates by 6%. Flextronics followed this up by beating the Q4 consensus EPS estimates, though the stock then missed Q1 EPS consensus estimates.

While headline results have been disappointing recently, Flextronics continues to make progress in its transition towards higher margin segments:

High reliability solutions [HRS] and and Industrial & Emerging industries [IEI] jumped to 36% of revenue this quarter, up from 30% last year.

Both these segments have (or at least projected to have) much higher operating margins than the core consumer technology [CTG] and integrated network solutions [INS] segments:

The ranges presented for each segment reflect what management projected operating margins to be, while the blue peg represents what they actually were. As you can see in the orange IEI scale, operating margins were way below projections at 2.6% (versus a projected range of 4% to 6%).

D) Thesis Moving Forward

We'll remind investors that we are quants who sift through academic papers and historical data to find repeatable patterns that can be exploited for profit. We've distilled our insights into an equity-pricing model that seeks to use historical back testing to generate 12-month price targets that are more accurate than the Wall Street consensus.

Our core thesis remains from our initial report, as we believe there is still significant upside available in Flextronics. The stock remains extremely cheap from a relative standpoint. The chart below shows how Flextronics ranks versus the market on five common valuation metrics:

With trailing twelve-month sales of $25.1 billion and a market cap of $6.17 billion, Flextronics currently sports a sales yield of 406% ($25.1/$6.17). This puts it in the 95th percentile of all stocks in the market ranked by sales yield.

Historical back testing shows that stocks ranked within the 90th to 99th percentile (i.e. top 10%) of the market by sales yield have historically beaten the market by 4.11% a year, on average:

Flextronics is also severely undervalued from an earnings and free cash flow basis. The stock's 8.7% earnings yield and 25% free cash flow yield are ranked in the 88th and 82nd percentile of the market, respectively.

Stocks ranked in the 80th to 89th percentile of the market based on earnings yield have historically outperformed the market by 4.06% a year on average:

Stocks ranked in the 80th to 89th percentile of the market based on free cash flow yield have beaten the market by 2.7% a year, on average:

It's clear that history favors Flextronics position right now, as the market has consistently rewarded investors of cheap stocks with significant alpha. This is because cheap stocks are either embarrassing to hold or are part of boring industries with little "excitement".

Flextronics fits into the latter category, as the contract manufacturing industry is far removed from the excitement surrounding their branded customers. Over time, this inefficiency will correct itself as it always does and investors should expect Flextronics to be a major beneficiary.

Next, we'll analyze Flextronics' price momentum, growth, and profitability profile. Again, we'll look to the past to see how stocks in similar situations have historically performed. The chart below ranks Flextronics on five different growth metrics within the market:

Flextronics momentum has slowed recently, with the stock price falling 2.7% over the last six months and gaining a mere 5.7% over the last twelve. In both metrics, Flextronics falls near the middle of the market and shouldn't materially impact returns moving forward. Earnings have grown 12% over the last 12 months compared to the same period a year ago, which is more than double the median of the market.

The one metric that is impressive in the chart above is the company's 22.4% return on equity. This is more than double the median stock's ROE in the market, and puts it in the 84th percentile of the market ranked on ROE. Historical back testing shows that stocks ranked within the 80th to 89th percentile of the market by ROE have historically beaten the market by 1.58% a year, on average:

Unlike value, we don't expect Flextronics growth profile to contribute significant alpha moving forward. With that being said, considering Flextronics extremely cheap valuation, it is noteworthy that the company is highly profitable and growing earnings at all.

Next, we'll analyze Flextronics sentiment profile, looking at how the "smart money" (i.e. short sellers, institutions, and company insiders) is trading the stock. These investors tend to have an informational advantage over the average market participant and their transactions often foreshadow future movements in price.

Of the three metrics listed above, the short interest ratio is by far the most important. This is due to new regulations that decrease the ability of insiders to profit from illegal insider information. Institutional transactions are also important, but they tend to be stale as they are only released once quarter (versus the timelier bi-weekly short interest report).

Thus, while it is slightly discouraging that Flextronics company insiders have been dumping stock recently, investors should pay more heed to the stock's extremely low short interest ratio. This disparity in metric importance is reflected in the historical backtests.

Stocks ranked in the 70th to 79th percentile of the market based on short interest have beaten the market by 2.45% a year, on average:

While stocks that are ranked in the 0th to 9th percentile of the market based on company insider transactions (i.e. the 10% of stocks experiencing the greatest decrease in company insider ownership change) have historically underperformed the market by 1.88% a year, on average:

Similar to its growth, we don't expect Flextronics sentiment profile to meaningfully contribute alpha moving forward.

This brings us to our projected 12-month price targets. Our equity pricing model use historical back testing to predict the amount of "excess returns" (i.e alpha) a stock will generate. It combines this with the stock's beta to project a range of 12-month target prices. This range is expected to have a 75% area of accuracy (i.e. the stock price will be within the price range 75% of the time). These projections are shown below:

On our base case, the Quantified Alpha algorithms expect Flextronics to rise from its current price of $10.89 to $12.94 over the next twelve months. This represents upside of 19.20% from current prices.

Our algorithms project a 75% probability that Flextronics stock price will be between $10.24 to $15.72 in 12 months. This ranges from potential downside of -5.98% to potential upside of +44.36%. Risk-reward looks skewed to the upside.

These are slightly more optimistic projections than Wall Street analysts, who currently have an average 12-month price target of $12.24 (representing upside of 12.4% from current prices).

E) Conclusions

Flextronics has historically experienced low levels of price volatility. This means that Flextronics options tend to be overly cheap. When buying calls, we focus on long-term in-the-money options. They tend to have high proportions of intrinsic value relative to time value priced into the options. This allows investors to benefit from the leverage inherent within options, while avoiding the speculative nature of out-of-the-money options.

In particular, we think the January 15th $10 and $11 call options look attractive. The $10 options were last traded for $1.45, which means that investors just need a $0.45 move (4.1% gain) from now till the expiry date to break even on the trade. The $11 options are a bit more speculative, as they last traded at $0.75. This means investors would need a 6.2% upside move from now till expiry to break even on the trade.

A) Introduction

Voya Financial Inc (NYSE:VOYA) is a diversified financial company offering life insurance, financial planning, and investment management for 13 million customers with assets totaling $486 billion. We believe the company offers a rare opportunity in which the stock combines an attractive valuation with excellent earnings growth and strong price momentum. Each of these factors is a good determinant of future success, and we will outline why as we progress through the analysis.

The report will start with a breakdown of Voya's valuation profile, then will proceed to an analysis of the price and profit growth, followed by an analysis of recent "smart money" transactions, and concluding with some qualitative analysis and conclusions. Perhaps due to its recent entrance into the public markets, the company remains far too cheap for its current trajectory. Voya is poised for significantly more upside over the next twelve months.

B) Value

We take a quantitative approach to investing, preferring to focus our analysis on a certain set of metrics that have a strong predictive ability. We'll start by analyzing Voya's value profile. This is important to look at as "Value stocks (with low ratios of price to book value) have higher average returns than growth stocks (high price-to-book ratios)". Voya's valuation profile is shown below:

Voya is a very cheap stock. Twelve-month sales are larger than the current market cap, as evidenced by its 103% sales yield. The company is extremely cheap from an earnings basis as well with its 23% earnings yield more than five times the market median. The stock trades at an outrageously low price to book multiple of 0.57, which is in the 95th percentile of all stocks in the market (100 being lowest P/B). Voya is also a free cash flow machine, which is reflected by the companies 37% FCF yield.

Our algorithms project Voya's cheap valuation to contribute 7.07% of alpha moving forward, based on how companies with similarly cheap valuations have historically outperformed. This puts it in the 96th percentile of all stocks based on value.

C) Momentum, Growth, and Profitability

There are a variety of different growth metrics that have been shown to predict stock returns. Most important among them is price momentum. Winning stocks keep winning, and losing stocks tend to keep losing. Voya's growth profile is shown below:

Voya has recently been gathering momentum. Its stock price has gained 27% over the last twelve months, and 18% over the last six. The company is also seeing huge bottom-line growth. Earnings have grown 92.4% over the last four quarters while management has also kept Voya efficient, shown by its 14% return on equity.

Our algorithms project Voya's solid momentum and profitability profile to contribute 3.04% of alpha moving forward, based on how companies with similarly strong growth have historically outperformed. This puts it in the 82nd percentile of all stocks based on growth.

D) "Smart Money" Sentiment

In addition to value and momentum, we will also analyze how the "smart money" on the street is playing Voya. "Smart money" stakeholders are short sellers, company insiders, and institutions. Each of these stakeholders tends to be much more sophisticated than the average investor. We have found loads of academic research showing that short sellers, company insiders, and institutions all predict stock returns. This breakdown is shown below:

While the market has ignored Voya, it's clear that the 'smart money' hasn't. Institutional investors have recently increased their positions in the stock, shown by the 3.3% increase in institutional ownership over the last three months. Company insiders have been selling, though this reflects a market-wide trend. Short interest remains an extremely low at 1.2% of the total float, reflecting little conviction that the stock is headed lower.

Overall, our algorithms project Voya's sentiment profile to contribute 5.84% of alpha moving forward, based on how companies with similar levels of sentiment have historically outperformed. This puts it in the 96th percentile of all stocks based on sentiment.

E) Earnings Momentum

Next, we'll see how Voya has been performing relative to analyst expectations recently. This is key to watch, as stocks that beat analyst estimates often see big jumps in price. This is doubly important for Voya, as they release earnings this week. Thus, it is crucial for investors to anticipate whether earnings will beat expectations ahead of time. Our earnings model allows us to do this, with a high level of accuracy.

Voya's earnings history is shown below, with the grey line representing how much Voya's reported EPS figure deviated from estimates:

Voya has only missed EPS estimates once since its IPO. It consistently beats expectations by a wide margin, with last quarter's reported EPS being 10% higher than analyst estimates. This is a very good sign for the upcoming earnings release, as it means that analysts have a history of conservatively forecasting Voya's EPS. This brings us to our projections for this quarter:

Our algorithms project a 65-75% probability that Voya will beat analyst EPS estimates this quarter, with the expected beat size to be small (0-5% ahead of estimates). The project a slightly lower likelihood of an upside surprise on revenue estimates (55-65% chance), though with a likely larger surprise if they do beat (5-10% ahead of estimates).

Voya releases earnings on Tuesday, before the market open. Wall street analysts are currently forecasting EPS of $0.84, and revenue of $335.22 million. Expect the actual EPS to come in at $0.86 (range of $0.84 to 0.88), and for revenue to be $360 million (range of $353 to $369 million). Overall, we rate Voya's earnings momentum strength to be a solid 3.5 stars out of five.

F) Qualitative Analysis

Looking beyond the numbers, we see two big catalysts that will directly impact earnings over the next twelve months and help propel the stock price upwards.

Voya is an extremely shareholder friendly company and has consistently bought back shares of the company. Management understands that the company is currently undervalued, and is taking advantage of the situation by buying back huge amounts of shares. Buybacks have twin benefits. First, they provide a steady source of buying power and protect the stock price from any sharp falls (as management would likely use price declines to buyback stock). Second, they increase future earnings per share by reducing the float. Academic studies have shown that companies that buy back their own shares tend to outperform the market.

The second main catalyst is Voya's continued ROE and ROC expansion, shown in the chart below:

Voya has managed to increase its return on equity and return on capital every year since fiscal 2012. The company is targeting a 13-14% ROE for 2018, and 11-12% ROC by 2018. Given the company's current growth trajectory, this looks conservative and highly achievable.

G) Conclusions

This brings us to our projected 12-month price targets. Our equity pricing model use historical back testing to predict the amount of "excess returns" (i.e alpha) a stock will generate. It combines this with the stock's beta to project a base case target price, as well as a range of potential prices. This range is expected to have a 75% area of accuracy (i.e. the stock price has a 75% probability of being within the range in 12 months). These projections are shown below:

In our base case, the Quantified Alpha algorithms expect Voya to rise from its current price of $46.73 to $58.76 over the next twelve months (representing a 12-month return of +25.74%). We project a 75% probability that Voya's stock price will be between $49.18 to $67.41 in 12 months. We're far more optimistic than Wall Street analysts, who currently have an average 12-month price target of $50.04 (representing upside of 7.08% from yesterday's close).

There is very little liquidity in Voya's long-term options so investors who want to take advantage of this opportunity must do so through common equity. Given the volatile nature of earnings, it may be a good idea to sit tight until after earnings are released on Tuesday.

Our quantitative earnings model predicts that Disney (NYSE:DIS) will report EPS and revenue this quarter that will exceed current analyst expectations. The company is expected to release earnings after the market close this afternoon.

We'll start by providing our projections, proceed to an explanation of the rationale behind the projections, and finish with some additional analysis and supplementary charts. Our track record of past quarterly earnings predictions made by the model can be found here.

EPS Projections

On average, sell-side analysts on Wall Street expect Disney to report $1.39 in EPS for this quarter. Our model projects a 65-75% probability that Disney will beat these projections. It expects a large beat on estimates, ranging from 5-10% higher than consensus (EPS between $1.46 to $1.53).

Revenue Projections

On average, sell-side analysts on Wall Street expect Disney to report revenue of $13.17 billion for this quarter. Our model projects a 65-75% probability that Disney will beat these projections. It expects a small beat on estimates, ranging from 0-5% higher than consensus (revenue between $13.18B to $13.82B).

Rationale

Analyst estimates are consistently too conservative as companies beat earnings estimates over 60% of the time. Analysts may do this to stimulate trading (e.g., Hayes 1998), to obtain access to management (e.g., Lim 2001) or to confirm a prior sentiment on a stock (e.g. Hwang 1996). Either way, analysts are incentivized to "play nice" with the companies they cover, and this manifests itself in earnings estimates that are consistently lower than they should be.This pattern of earnings estimate manipulation can be taken to the extreme in certain companies. Thus, the most important factor to analyze when predicting whether a company will beat earnings estimates ahead of time is to look at its past track record of estimate beats. Disney's EPS beat history is shown below:

Last quarter, Disney beat the analyst consensus EPS estimate by 10.81%. This was the seventh quarter in a row that the company beat EPS estimates, and the ninth beat in the last ten quarters. Disney hasn't missed the EPS consensus at any point in the last 4 years. Its last EPS miss was May 10th, 2011 (FQ2 2011) when it missed by 14.04% and the stock price dropped by 5.42% in the 24 hours following the release.Disney is clearly a company that analysts consistently "play nice" with. This is possibly due its immense size, which increases the importance of the relationship for analysts. Nevertheless, investors can expect Disney to once again surpass the expectations that analysts have set for them.The same logic applies for revenue estimates. Disney's revenue beat history is shown below:

Last quarter, Disney beat the analyst revenue consensus estimate by 1.81%. This was the seventh quarter in a row that the company beat revenue estimates and its ninth beat in the last 10 quarters. Disney's revenue beat history is not as strong as its EPS track record, but it's still clear that it has a history of surpassing expectations. It is important to note that Disney rarely beats revenue expectations by much, with its biggest revenue beat being slightly above 4% in Q1 of this year.Another factor that plays a big role in our predictive model is the recent performance of Disney's stock price. We've found through extensive historical back testing that the market tends to anticipate strong earnings ahead of time, and thus stocks are bid up in price ahead of earnings. Below is a look at some of the inputs to our technical analysis model that shows how Disney's current price compares to its recent moving averages:

Disney is currently trading above its 20-day, 50-day, and 200-day simple moving averages. It's trading at 2.44% and 6.30% above its 20- and 50-day moving averages, and over 18.5% above its 200-day moving average. Additionally, Disney's stock price has gone up by 5.35% over the last 20 trading days, and its price hit a new 52-week high yesterday at $121.73. This shows that investors are feeling especially bullish about the stock as it heads into its earnings release.

CONCLUSIONS

While Disney is extremely likely to beat analyst estimates, that doesn't necessarily mean investors should buy the stock before the earnings release. On average, stocks that beat analyst estimates will rise in price by around 1-2%, but there is a huge amount of variation around these averages. Many stocks will actually decrease in price after strong earnings releases, because the market can have much higher expectations than Wall St. analysts.

Valuation is the best factor available when determining post-earnings announcement price changes. Cheap value stocks increase in price by a larger margin than expensive stocks after beating earnings estimates (e.g., Zhao 2009). The chart below shows how Disney ranks within the market on five crucial valuation ratios:

Disney's relative valuation is not attractive. Its sales yield of 24.67% ranks near the bottom of the market in the 21st percentile, and its dividend and free cash flow yields are also well below average. It also has a price/book multiple of 4.14x that is extremely high relative to the market, ranking in the 30th percentile of all stocks. While it's rare to say about a stock of such magnitude ($205.51B market cap), Disney's story is one of growth - which makes each subsequent earnings release crucial to keeping the story up. The chart below shows Disney's year-over-year (YoY) earnings and revenue growth rates:

Disney hasn't experienced a quarter of negative YoY earnings or revenue growth in the last 2 years. At $1.39 EPS, analysts are expecting YoY earnings growth of 8.6%, a sharp decline from the past two quarters where YoY EPS growth was 22.12% and 10.81%, respectively. At revenue of $13.17B, analysts are expecting YoY revenue growth of 5.69%, which is also much lower than the past two quarters where YoY revenue growth was 8.79% and 6.97%, respectively. Our estimates are more in line with Disney's recent growth rates, at 17.18% for EPS and 7.54% for revenue. Given the consistency with which Disney has crushed analyst estimates, it seems safe to assume that analysts are giving Disney a lot of room to offer a pleasant earnings "surprise" tomorrow.

It should also be noted that sophisticated investors are likely aware of this trend, and have come to anticipate earnings and revenue surprises for Disney. Thus, simply beating analyst estimates isn't enough to propel the stock's price higher. Over the past 12 quarters, Disney's price has only risen 5 times following an earnings beat. Over that period, all 3 revenue misses led to 24-hour price declines, as did both times that Disney only met Wall St. estimates. On average, Disney's stock price moves 2.34% following an earnings announcement; with an average upside of 3.39% and downside of 1.58%.

Based on its earnings history and its track record of crushing analyst estimates, Broadcom (NASDAQ:BRCM) will beat the $0.75 Wall St. consensus EPS estimate on Thursday afternoon.

We’ll start by providing our projections, proceed to an explanation of the rationale behind the projections, and finish with some additional analysis and supplementary charts. Our track record of past quarterly earnings predictions made by the model can be found here.

EPS PROJECTIONS

On average, sell-side analysts on Wall Street expect Broadcom to report $0.75 in EPS for this quarter. Our model projects a 65-75% probability that BRCM will beat these projections. It expects a large beat on estimates, ranging from 5-10% higher than consensus (EPS between $0.79 to $0.83).

REVENUE PROJECTIONS

On average, sell-side analysts on Wall Street expect Broadcom to report revenues of $2.11 billion for this quarter. Our model projects a 65-75% probability that BRCM will beat these projections. It expects a small beat on estimates, ranging from 0-5% higher than consensus (revenue between $2.12B to $2.21B).

RATIONALE

Analyst estimates are consistently too conservative as companies beat earnings estimates over 60% of the time. Analysts may do this to stimulate trading (e.g., Hayes 1998), to obtain access to management (e.g., Lim 2001) or to confirm a prior sentiment on a stock (e.g. Hwang 1996). In any case, analysts are incentivized to “play nice” with the companies that they cover, and this manifests itself in earnings estimates that are consistently lower than they should be.

This pattern of earnings estimate manipulation can be taken to the extreme in certain companies. Thus, an important factor to analyze when predicting whether a company will beat earnings estimates ahead of time is to look at its past track record of estimate beats. Broadcom appears to be an extreme example of earnings estimate manipulation as it almost never misses earnings estimates. Logically, you’d assume that analysts would simply revise their estimates higher (since they’re always too low) but for one reason or another, they don’t. Below is BRCM’s earnings history:

BRCM has only missed one EPS estimate in the last 10 quarters: FQ2 2013 when it missed by 2¢ on the Wall St. Consensus of $0.49 (4% miss). Since then, it hasn’t missed EPS and has beaten by an average of 15%. The trend in EPS beat size is clearly negative, as each of the last 3 beats have been smaller than the one prior. It should also be noted that over the last 24 quarters (6 years), BRCM has only missed on EPS twice, a remarkable consistency. A company’s recent EPS and revenue growth rates can also shine a light on growth trends in the company to see how analysts estimates compare to history. Below is BRCM’s EPS and revenue growth rates from the past 3 years.

The analyst consensus of $0.75 represents 63% Year-over-year (YoY) EPS growth from the $0.46 reported the same quarter a year ago. YoY EPS growth rose to 93.94% last quarter, and has been trending upwards ever since it was last negative FQ2 2012. Analysts are clearly expecting this EPS growth to slow down considerably to 63%, which seems overly pessimistic given the companies growth rate the past two quarters. Our estimate of $0.81 is more inline with BRCM’s current growth rates at 76%. Analysts appear to be continuing their trend of setting low expectations for BRCM.

From a revenue standpoint, analysts have been more inline with reported results, making revenue predictions based on past results less certain. Below is BRCM’s revenue history:  

The strongest pattern from the past 12 quarters of revenue estimates is that analysts consistently set expectations too high for FQ2 and too low throughout the rest of the year. This pattern counters the basis for an upcoming revenue beat. The $2.11B that analysts are expecting this quarter would represent 3.38% YoY revenue growth from the $2.04B reported in FQ2 2014. This 3.38% would be inline with the recent slowing of BRCM’s revenue growth rate and is in line with our predicted revenue beats of 0-5%.

Another factor that plays a big role in our predictive model is the recent performance of BRCM’s stock price. We’ve found through extensive historical back testing that the market tends to anticipate strong earnings ahead of time, and thus stocks are bid up in price ahead of earnings. Below is a look at some of the inputs to our technical analysis model, that shows how BRCM’s current price compares to its recent moving averages:

BRCM is underperforming its short-term moving averages of 20 and 50 days, but outperforming the longer moving average of 200 days. These numbers are highly influenced by the 21% price surge that BRCM experienced on May 27th when it announced that it would be acquired by Avago for $37 billion (the largest ever merger between chip makers). The stock is slowly correcting from the high of $57.70 from that day, but remains 12.5% higher than it closed on May 26th. These earnings may be of reduced importance given that the buyout price has been agreed upon (shareholders can elect Avago stock (0.4378 shares) or $54.50 in cash), but nonetheless, given the adverse effects of unexpected EPS misses on BRCM’s share price (and the smaller, positive effects of EPS beats) traders can use this opportunity to take a short-term position on the stock.

CONCLUSIONS

Broadcom shares have a 1-day average price change on earnings of 5.78%. Options are pricing in an implied move of 5.34% off earnings. While an EPS beat is more likely, the downside from a miss will have a greater effect on the stock’s price. The average gain following an EPS beat over the last 12 quarters has been 3.3%, while the average drop from a miss is 15%. Over those same 12 quarters, BRCM’s stock price has dropped 4 times following an EPS and revenue beat. Both revenue misses over those 12 quarters resulted in a price drop.

While we expect the recent buyout announcement to reduce the importance of this quarter’s earnings announcement, there is still an opportunity for traders to profit given the historical volatility of this stock’s share price on earnings day. We anticipate a large EPS beat with confidence, but feel less certain about a revenue beat given the downward trend in the company’s revenue growth. If history is any indication, expect a downward revision should BRCM fail to beat the $2.11 billion revenue estimate, and an even bigger revision should the company miss the $0.75 EPS estimate.

Based on its earnings history and its track record of crushing analyst estimates, Electronic Arts (NASDAQ:EA) will beat the -$0.09 Wall St. consensus EPS estimate on Thursday afternoon.

We'll start by providing our projections, proceed to an explanation of the rationale behind the projections, and finish with some additional analysis and supplementary charts. Our track record of past quarterly earnings predictions made by the model can be found here.

EPS PROJECTIONS

On average, sell-side analysts on Wall Street expect EA to report -$0.09 in EPS for this quarter. Our model projects a 75-100% probability that EA will beat these projections. It expects a huge beat on estimates, starting from 10% higher than consensus (EPS between -$0.08 to +$0.05).

REVENUE PROJECTIONS

On average, sell-side analysts on Wall Street expect EA to report revenues of $683.75 million for this quarter. Our model projects a 65-75% probability that EA will beat these projections. It expects a small beat on estimates, ranging from 0-5% higher than consensus (revenue between $684M to $717M).

RATIONALE

Analyst estimates are consistently too conservative as companies beat earnings estimates over 60% of the time. Analysts may do this to stimulate trading (e.g., Hayes 1998), to obtain access to management (e.g., Lim 2001) or to confirm a prior sentiment on a stock (e.g. Hwang 1996). In any case, analysts are incentivized to "play nice" with the companies that they cover, and this manifests itself in earnings estimates that are consistently lower than they should be.

This pattern of earnings estimate manipulation can be taken to the extreme in certain companies. Thus, an important factor to analyze when predicting whether a company will beat earnings estimates ahead of time is to look at its past track record of estimate beats. While EA may not be an extreme example of earnings estimate manipulation, it does have an unusually consistent track record of outperforming analyst estimates. Below is EA's earnings history:

EA has only missed one EPS estimate in the last 10 quarters: FQ4 2013 when it missed by 10¢ on the Wall St. Consensus of $0.51. Since then, it hasn't missed a Wall St. consensus estimate, and has beaten by an average of over 300% (median of 68%) marked by two massive beats coming in FQ2 2014 and FQ4 2014 of 1150% ($0.25 EPS vs. $0.02 Estimate) and 1066% ($0.35 EPS vs. $0.3 Estimate), respectively. Last quarter EA nearly doubled the Wall St. consensus of $0.14 by reporting $0.27 of EPS. Estimates of -$0.09 for this quarter are similar to those of -$0.13 from a year ago (FQ1 2014) that EA beat by over 175% by reporting +$0.10 EPS. Similarly, a year prior to that (FQ1 2013) analysts were calling for -$0.73 EPS and EA beat by 31% by reporting -$0.50. It should be noted however, that FQ1 2012 was a rare, albeit small, miss by EA of -4% when they missed estimates of -$0.51 by 2¢.

The analyst consensus of -$0.09 represents a 190% Year-over-year (YoY) revenue decline from the +$0.10 reported the same quarter a year ago. While YoY EPS growth has been negative the past 2 quarters, 190% decline is a far cry from the 22.86% and 4.27% declines of the past 2 quarters. Analysts are setting EPS expectations particularly low this quarter.

From a revenue standpoint, analysts have been much more inline with reported results, making revenue predictions based on past results less certain. Below is EA's revenue history:

The only pattern to be distinguished from the past 12 quarters is that analysts are consistently under-anticipating FQ4 and FQ1 revenues while consistently over-anticipating FQ2 and FQ3 revenues. This pattern supports the basis for an upcoming revenue beat of the $683.75M that analysts are expecting. In fact, that $683.75M would represent a 44% YoY revenue decline from the $1.21B reported in FQ1 2014. While it is unlikely that EA's revenues will surpass those from a year ago, which were boosted by stronger-than-expected sales of both "Titanfall" and "FIFA 2014", a 44% drop seems especially unlikely given that revenue has been growing by an average of 28% on a YoY basis over the past 4 quarters.

Another factor that plays a big role in our predictive model is the recent performance of EA's stock price. We've found through extensive historical back testing that the market tends to anticipate strong earnings ahead of time, and thus stocks are bid up in price ahead of earnings. Below is a look at some of the inputs to our technical analysis model, that shows how EA's current price compares to its recent moving averages:

EA is outperforming its moving averages over all three time horizons: 20, 50, and 200 days. EA's stock price has gone up by 6.17% (at the time of writing) over just the last 20 days showing that investors are feeling especially bullish heading into this Thursday's earnings release.

CONCLUSIONS

Option traders clearly support our thesis, as they expect Electronic Arts to rally after it reports earnings on Thursday. There was heavy volume in EA's Weekly 72 calls that expire just one trading session after earnings are reported. Total option volume in EA quadrupled its daily average for the last month, with overall calls outnumbering puts by 3 to 1. Option traders may be feeling this way because of the recent trend in EA's earnings day rallies, with prices rising an average of 5.4% from close-to-close over the last 8 quarters following earnings.

While we anticipate an earnings beat, there are other factors to consider when deciding whether the market will react favorably to the earnings call. First, it should be recognized that the market may have unrealistically high expectations for EA given its earnings day track record. An example a year ago (FQ1 2014), when EA's price dropped by 6.2% in 24 hours following earnings after reporting unexpectedly strong results (beat EPS by 175% and revenue by 70%.) The reason for the decline is likely because EA guided only inlinewith the Street for Q2 and left unchanged its FY15 guidance.

Our quantitative earnings model predicts that Visa (V) will report EPS and revenue this quarter that will exceed current analyst expectations. The company is expected to release earnings after the market close today.

We'll start by providing our projections, proceed to an explanation of the rationale behind the projections, and finish with some additional analysis and supplementary charts. Our track record of past quarterly earnings predictions made by the model can be found here.

EPS PROJECTIONS

On average, sell-side analysts on Wall Street expect Visa to report $0.59 in EPS for this quarter. Our model projects a 65-75% probability that Visa will beat these projections. It expects a large beat on estimates, ranging from 5-10% higher than consensus (EPS between $0.62 to $0.65).

Within this range, we expect Visa to report at the lower end of this range at $0.62.

Revenue Projections

On average, sell-side analysts on Wall Street expect Visa to report sales of $3.36 billion for this quarter. Our model projects a 65-75% probability that Visa will beat these projections. It expects a small beat on estimates, ranging from 0-5% higher than consensus (revenue between $3.36b to $3.53b).

Within this range, we expect Visa report at the low end of the range at $3.40 billion.

Rationale

Analyst estimates are consistently too conservative as companies beat earnings estimates over 60% of the time. Analysts may do this to stimulate trading (e.g., Hayes 1998), to obtain access to management (e.g., Lim 2001) or to confirm a prior sentiment on a stock (e.g. Hwang 1996). Either way, analysts are incentivized to "play nice" with the companies they cover, and this manifests itself in earnings estimates that are consistently lower than they should be.

This pattern of earnings estimate manipulation can be taken to the extreme in certain companies. Thus, the most important factor to analyze when predicting whether a company will beat earnings estimates ahead of time is to look at its past track record of estimate beats. Visa’s EPS beat history is shown below:

Last quarter, Visa beat the analyst consensus EPS estimate by 1.6%. This was the sixth quarter in a row that the company beat EPS estimates, and the ninth beat in the last ten quarters. Visa hasn’t missed the EPS consensus at any point in the last 3 years.

Visa is clearly a company that analysts consistently "play nice" with. This is possibly due its immense size, which increases the importance of the relationship for analysts. Nevertheless, investors can expect Visa to once again surpass the expectations that analysts have set for them.

The same logic applies for revenue estimates. Visa's revenue beat history is shown below:

Last quarter, Visa beat the analyst revenue consensus estimate by 2.5%. This was the third quarter in a row that the company beat revenue estimates and its seventh beat in the last 10 quarters. Visa's revenue beat history is not as strong as its EPS track record, but it's still clear that they have a history of surpassing expectations. It is important to note that Visa rarely beats revenue expectations by much, with their biggest revenue beat being slightly above 3% in Q3 of 2013.

Another factor that plays a big role in our predictive model is the recent performance of Visa's stock price. We've found through extensive historical back testing that the market tends to anticipate strong earnings ahead of time, and thus stocks are bid up in price ahead of earnings.

Another factor that plays a big role in our predictive model is the recent performance of Visa’s stock price. We’ve found through extensive historical back testing that the market tends to anticipate strong earnings ahead of time, and thus stocks are bid up in price ahead of earnings. Below is a look at some of the inputs to our technical analysis model that shows how Visa’s current price compares to its recent moving averages:

Visa is currently trading above its 20-day, 50-day, and 200-day simple moving averages. It is 4.6% and 4.4% above its 20- and 50-day moving averages, and over 11% above its 200-day moving average. Additionally, Visa’s stock price has gone up by 5% over the last 20 days, and its price is only 1.3% below its 52-week high. This shows that investors are feeling especially bullish about the stock as it heads into its earnings release.

With two upward revisions to both EPS and revenue estimates in the last seven days, it is looking highly likely that Visa will beat the Wall St. consensus estimates.

CONCLUSIONS

While Visa is extremely likely to beat analyst estimates, that doesn’t necessarily mean investors should buy the stock before the earnings release. On average, stocks that beat analyst estimates will rise in stock price by around 1-2%, but there is a huge amount of variation around these averages. Many stocks will actually decrease in price after strong earnings releases, because the market can have much higher expectations than Wall St. analysts.

Valuation is the best factor available when determining post-earnings announcement price changes. Cheap value stocks increase in price by a larger margin than expensive stocks after beating earnings estimates (e.g., Zhao 2009). The chart below shows how Visa ranks within the market on five crucial valuation ratios:

Visa’s relative valuation is not attractive. Its sales yield of 7.5% ranks at the absolute bottom of the market (5th percentile). Its price/book multiple of 5.69x is also extremely high relative to the market, ranking in the 22nd percentile of all stocks in the market.

Based on its earnings history and its track record of beating analyst estimates, Under Armour (UA) will beat the $0.05 Wall St. consensus EPS estimate and the $761.77M revenue estimate tomorrow morning. It’s important to note that this won’t guarantee positive investor sentiment, however, as UA investors likely recognize that the company never misses Wall St. analyst estimates. As a result, investors have very different markers in mind when considering whether Under Armour’s earnings results are good or bad news. Four of the last six earnings days have resulted in downward price trends, despite none of the six missing Wall St. consensus estimates. 

We’ll start by providing our projections, proceed to an explanation of the rationale behind the projections, and finish with some additional analysis and supplementary charts. Our track record of past quarterly earnings predictions made by the model can be found here.

EPS PROJECTIONS

On average, sell-side analysts on Wall Street expect Under Armour to report $0.05 in EPS for this quarter. Our model projects a 55-65% probability that UA will beat these projections.

REVENUE PROJECTIONS

On average, sell-side analysts on Wall Street expect Under Armour to report revenues of $761.77 million for this quarter. Our model projects a 65-75% probability that UA will beat these projections. It expects a small beat on estimates, ranging from 0-5% higher than consensus (revenue between $762M - $800M).

RATIONALE

Analyst estimates are consistently too conservative as companies beat earnings estimates over 60% of the time. Analysts may do this to stimulate trading (e.g., Hayes 1998), to obtain access to management (e.g., Lim 2001) or to confirm a prior sentiment on a stock (e.g. Hwang 1996). In any case, analysts are incentivized to “play nice” with the companies that they cover, and this manifests itself in earnings estimates that are consistently lower than they should be.

This pattern of earnings estimate manipulation can be taken to the extreme in certain companies. Thus, the most important factor to analyze when predicting whether a company will beat earnings estimates ahead of time is to look at its past track record of estimate beats. Under Armour may not be an extreme example of earnings estimate manipulation, but it does appear to be on an extreme example of revenue estimate manipulation. Below is Under Armour's EPS history compared to the analyst consensus.

Last quarter, Under Armour matched the consensus EPS estimate of $0.05. However, investors clearly had higher expectations than Wall St. analysts as the stock price fell 4.83% in just that one trading day. It makes sense that investors expect more than the Wall St. consensus for Under Armour, as the company has never missed the consensus EPS estimate. Over the course of nearly 40 EPS announcements, Wall St. analysts have never been overly optimistic. Expect a significant drop in price if Under Armour only matches the $0.05 consensus EPS estimate this time around.

The reported EPS of $0.05 represented a 16.67% YoY earnings decline over FQ1 2014’s reported EPS of $0.06. The Wall St. consensus EPS estimate of $0.05 for this quarter represents an expected YoY earnings decline of 37.5% - over twice the EPS decline of last quarter. Analysts are giving Under Armour a lot of leeway to beat their estimates this quarter. Expect Under Armour to beat these expectations, even if only by 1 or 2 cents.

As we mentioned before, this pattern of beating analyst expectations is even stronger on the revenue side. Under Armour’s revenue surprise history is shown below:

Last quarter’s reported revenue of $804.94 million exceeded the Wall St. consensus of $801.16 million by 0.5%. It also represented positive revenue growth of 25.5% from the same quarter a year before. This quarter’s consensus revenue estimate of $761.77 would represent YoY revenue growth of 25% from Q2 2014.

Another factor that plays a big role in our predictive model is the recent performance of Under Armour’s stock price. We’ve found through extensive historical back testing that the market tends to anticipate strong earnings ahead of time, and thus stocks are bid up in price ahead of earnings. Below is a look at some of the inputs to our technical analysis model, that shows how Under Armour’s current price compares to its recent moving averages:

Under Armour is currently trading above its 20-day, 50-day, and 200-day simple moving averages. Under Armour’s stock price has gone up by 6.2% over the last 20 days, and its price is only 10% below its 52-week high, showing that investors are feeling especially bullish about the stock heading into its earnings release. With two upward revisions to both EPS and revenue estimates in the last seven days, it is looking highly likely that Under Armour will beat the Wall St. consensus estimates.

CONCLUSIONS

While we’re confident that Under Armour will beat analyst estimates, that does not necessarily mean that we advise buying the stock before the earnings release. On average, stocks that beat analyst estimates will rise in stock price by around 1-2%. However, there is a huge amount of variation around this average, and many stocks will actually decrease in price even after strong earnings releases.

Over the last 6 quarters, Under Armour’s price has only gone up twice following a beat. As mentioned previously, after last quarter’s EPS match UA dropped 4.83% from close to close. The two times that UA’s earnings report resulted in close-to-close price gains have been huge. The most recent came one year ago, July 24th 2014, when UA’s market cap rose by 14.71% in one day on the heels of strong revenue growth (beat consensus by 6.5%) and an EPS match. The previous earnings day gain came on January 30th of last year when UA gained 22.93% in one trading session, also thanks to record sales growth and upward yearly revisions - EPS also beat the consensus by 50% (2¢) and revenue beat by 7.43%. None of the earnings day price declines in the past year have been large in scale.

While we usually profile companies with peculiarly consistent earnings histories, today we’re going to profile a giant with an inconsistent earnings history. General Motors is expected to report earnings tomorrow morning before market open. Based on its earnings history, we see a strong probability of an earnings beat but a high chance of a miss on revenue estimates.

GM EARNINGS & REVENUE  BEAT HISTORY

Wall St. Analysts are anticipating EPS of $1.09 and revenue of $40.20B from GM when they release tomorrow. Based on its earnings history, our quantitative model predicts a 55-65% probability that GM will beat these EPS estimates by a small (0-5%) amount, and a low (0-45%) chance of a revenue beat – i.e. an expected revenue miss. This is based on GM’s weak earnings day history, as illustrated below:

GM missed last quarter’s EPS consensus estimate by 11.34%, marking it’s fifth miss in the last ten quarters.

It also missed the revenue consensus estimates last quarter by 7.33%, marking GM’s sixth straight revenue miss:

The $40.20B revenue estimate represents a 1.3% year-over-year (YoY) revenue growth rate over the FQ2 2014 reported revenue of $39.65B. The image below shows GM’s YoY growth rates for revenue and EPS. As shown below, revenue growth has been flat for the last eight quarters while the EPS growth rate has accelerated over the last year.

Considering that revenue growth has been in decline since FQ2 2013, and has been negative for the past 2 quarters, +1.3% revenue growth seems overly optimistic. The projected EPS of $1.09 would represent YoY earnings growth of 88%. While this is a huge number, it is right in line with the YoY earnings growth rates of the last two quarters of 77.61% and 196.55%.

While we anticipate a likely revenue miss, the potential upside from an EPS beat is attractive for a value stock like GM. Cheap value stocks increase in price by a larger margin than expensive stocks after beating earnings estimates (e.g., Zhao 2009). Thus, it is important to consider GM’s value profile to see if an EPS beat will lead to gains for shareholders. Below is GM’s value profile relative to both the market and the automobiles group on 5 key value metrics:

It’s quite clear that GM is trading at an attractive entry price for investors looking to take a long-term position in the company. GM ranks near the top ten percent of the market based on sales, earnings, and free cash flow yields. It also offers an attractive 4.74% dividend yield, ranking near the top fifteen percent of the market in the metric. GM also has the most attractive value profile of the entire automobiles group.

From a technical standpoint, GM is trading below its 20, 50, and 200-day moving averages and is trading far below its 52-week high. The stock is clearly trending downwards, having lost 15.8% of its market cap in the last 20 trading days. This has helped its valuation profile, which presents an opportunity for longer-term buy-and-hold investors. A huge EPS beat and relatively strong revenue release would reverse the current downtrend, and likely lead to a significant gain in stock price. While we’re confident that GM will beat EPS expectations, we’re equally confident  that they will miss revenue as well.

GM has only gained on earnings day twice in the last 6 quarters, following the only two EPS beats of that period. It gained 5% from close-to-close after its 40% EPS beat in FQ4 2014, and gained 1.52% from close-to-close after its 2.11% EPS beat in FQ3 2014. It’s largest drop in price came the previous quarter, FQ2 2014, when it lost 4.45% from close-to-close following a 25.64% EPS miss. GM’s earnings day price moves are quite clearly dependent on its EPS performance relative to Wall St. expectations. Though we expect a large revenue miss, given its value profile there is a chance for significant upside should GM surprise EPS estimates tomorrow.