There is a growing trend for companies to report better than expected earnings and this is something that investors should follow. Earnings growth is one of the strongest catalysts for share price growth, so it pays to watch the companies doing well operationally and financially.

Beating estimates in the current environment could be down to several reasons including management being too cautious following the first lockdown and underestimating the potential for earnings to recover.

Analysts have been slow to upgrade their forecasts, perhaps also due to being too cautious, and therefore the market consensus has been too low for many stocks.

In July, we wrote an article about how stocks with the largest upward earnings revisions often go on to significantly beat the average market return over a three-month period.

In that article we published a list of stocks that had seen the biggest earnings upgrades by analysts over the previous month. From that list, 15 of the 20 stocks subsequently beat the market’s 5% gain as measured by the FTSE All-Share. Many of the stocks outperformed by a significant margin.

Trackwise Designs (TWD:AIM) increased by 256% between 14 July and 20 November.

The company had already seen upgrades following 2019 results which helped put it on our original list of stocks with earnings momentum. It then won an important contract in September with an electric vehicle manufacturer, which triggered further earnings upgrades and put the stock on the radar of more investors.

Buying stocks with the biggest earnings upgrades isn’t a guaranteed winning strategy. For example, education specialist RM (RM.) has lost 25.7% since our July article. However, the average return from the 20 stocks was 38% in the period, showing how diversification can benefit this strategy.

While there are recent examples of companies giving more optimistic commentary on their outlook, in general we would expect ongoing caution from most management teams while lockdown restrictions are still in place.

Such caution could easily change upon the approval of a Covid-19 vaccine, but for now we think there is the potential for more companies to beat expectations with trading. The stocks with the biggest upgrades over the past month feature in the accompanying table if you want to consider the earnings momentum investment strategy.

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