During the course of earnings season it is not uncommon for investors to pile into companies that have reported earnings that beat their consensus estimates. The behavior of stock prices in general during these periods denote a shoot-first-ask-later approach where, for the most part, the headline number trumps most other factors. Investors therefore tend to favor companies reporting positive surprises and shun those that miss the estimate. While there’s nothing wrong with this approach (we use an earnings surprise filter ourselves in some of our indexes’ methodologies,) this collective behavior in our opinion does something more important than reinforce common wisdom: it uncovers value opportunities for patient investors willing to do their homework. Thus, among the rubble of socks beaten down following poor earnings reports, a rigorous research process can yield a decent collection of hidden gems.

Using MarketGrader’s fundamental methodology and a few basic filters we have discovered ten such companies that may prove recent detractors wrong if held for a long enough period of time. These are typical value plays, opportunities that arise after a small bump on the road scares away the crowd. In order to arrive at our group of stocks we applied a few ground rules to our search process in order to distill our list from the hundreds of companies that have already reported earnings this season to the ten listed below, typically covering the first quarter of 2010.

We started by looking for companies that were already highly graded by MarketGrader before their latest report and that remained highly graded following their announcement, even if they missed their consensus estimate. While a positive earnings surprise is certainly preferable to a negative one, a single EPS headline number is not the catchall figure it is made out to be. Therefore, if a company’s fundamentals continue to get high marks from the MarketGrader system across our Growth, Value, Profitability and Cash Flow indicators even after a negative earnings surprise, then its fundamentals are sound and the stock warrants a second look.

We then focused on finding companies whose latest earnings announcement was received negatively by the Street by looking for those with drops in the price of the stock following their report. Such drops are precisely what increase the appeal for investors from a value perspective, as long as the fundamentals hold, of course.

We then refined our search for value even further by looking for companies whose MarketGrader overall Value grade (or rating) is actually higher than our overall Balanced (or default) grade.

Finally we looked at each stock’s MarketGrader Sentiment indicator to get a better sense of the Street’s general view on its prospects. In looking at the final results of our search it’s worth noting that five of the ten companies in our list missed their consensus estimate while four beat it and one met it. Below we highlight three of the stocks on the list, which you may see on the table at the bottom of the page.

1. Gilead Sciences (GILD) reported earnings per share of $0.92 on April 20^th, missing its consensus estimate of $0.96 by just 4%. The stock fell 11% following the report (we measure the change in price from the day before the announcement to the close of the day after it.) Its MarketGrader overall grade barely fell, from 86.3 to 81.1, which still makes Gilead one of our top ten grades in the Health Care sector, where MarketGrader covers 672 companies. From a Value perspective Gilead’s grade is even higher, at 83.5. The stock, currently trading at $40.25 has a trailing P/E of 12.6 and a forward P/E of 11.2.
2. NewMarket Corp. (NEU) reported earnings per share of $2.78 on April 21^st, beating the $2.62 estimate by 6%. The stock, which fell 4.5% after the report now trades at $112, or 9.9 and 10.1 times trailing and forward earnings respectively. Its overall grade actually improved to 80.1 from 77.8 after we incorporated the company’s latest financials into our analysis. Its Value overall grade is even higher at 85.9.
3. Diamond Offshore Drilling (DO) reported earnings per share of $2.09 on April 22^nd, 8.3% higher than the Street’s estimate of $1.93. The stock’s overall grade of 66.7 was virtually unchanged after the report. Diamond Offshore Drilling may appear as the riskiest stock in our list and it has a good chance of being one of the most volatile in the next few months for a few different reasons. First, the contrast between our Growth (D) and Value (B+) indicators is very significant and the biggest among all the stocks in our list. From a Value perspective our overall grade is 79.6 compared to 58.5 from a Growth perspective (our Buy, Hold or Sell rating for every company is determined by our ‘Balanced’ overall grade, which takes into account our Growth and Value indicators in addition to our Profitability and Cash Flow indicators.) Second, the stock’s Sentiment indicator is negative, underscoring the Street’s negative perception of it, which has a short-term effect on the supply and demand for the company’s shares. And to top things off, last week’s explosion of a Transocean (RIG) deep-water rig in the Gulf of Mexico and the ongoing fallout from it is certain to cast a shadow over the industry and have a chilling effect on the government’s plans to open new federal waters to new exploration. On paper this would appear to dim the prospects of drillers such as DO and RIG in the U.S. Nevertheless, Diamond Offshore Drilling has been for a long time a very capable operator with strong fundamentals and usually favorable MarketGrader ratings. Its stock is up 94.83% over the last five years.

Earnings Season Value Opportunities