TRADING STOCKS OFF

of news releases used to be easy money if you had the right technology. Now it's a free-for-all. I witnessed the change in the mid-1990s when I was working as a stockbroker. My best customer the company's best customer had a nuclear-hotline-style phone that rang on my desk the moment he lifted the handset. "Flip," I'll call him, would watch an expensive scrolling news terminal from his home, call the moment a company beat earnings estimates by a penny and be in and out of a big trade in minutes. He racked up profits a half-point at a time, and I collected discounted but plentiful commissions.

The Internet convinced Flip it was time to retire. Stocks began moving too fast once everyone had scrolling news and could place their own trades. "It's gotten to the point where long-term investing is a better deal," he said.

That's surely true for most of us. But even slowpokes and long-term holders can use earnings surprises profitably. A new study, in fact, suggests investors who use earnings surprises the right way can double the market's average return of 10 percent a year. That's a profitpalooza: Invest $10,000 for two decades, and it's the difference between $383,000 and $67,000.

The finding is based on an oddity that researchers have written about since the 1960s, called post-earnings announcement drift, or PEAD. Simply put, stocks don't fully "price in" good earnings news immediately after it's released. They tend to jump right away, and then gradually drift higher for up to a year. PEAD has done more than perhaps any other financial phenomenon to blow holes in the notion that markets are perfectly efficient.

That said, strategies based solely on PEAD aren't as profitable as they used to be. Earnings surprises these days, for one thing, are smaller than they were decades ago. More pros are scrutinizing larger volumes of information now, and more analysts contribute to estimates. Wall Street has gotten better at figuring out how much companies will earn next quarter. (Or perhaps, companies have gotten better at hinting.) Recent studies show that investors who buy after upside-earnings surprises can expect to beat the market by around three percentage points over the following six months.

Enter Narasimhan Jegadeesh. A finance professor and market researcher, he has consulted for and sold stock-picking models to Morgan Stanley and Deephaven Capital Management, a Minnesota hedge fund. Today he teaches investing at Emory University, occasionally playing point guard in basketball games against his Ph.D. candidates. (Undergrads run too much, he says.) Earlier this year Jegadeesh, along with Joshua Livnat, who teaches accounting at New York University, published a groundbreaking paper in the Financial Analysts Journal.

The study focuses on separating high-quality surprises from lower-quality ones. A soft-drink maker might crush estimates thanks to runaway demand for its energy drink (think Hansen Natural). That's clearly good news. A tire maker may top estimates even while selling fewer tires if it steers customers toward the most expensive ones and cuts jobs (Goodyear). That's okay, but it may not send the stock on a prolonged run.

How, then, can we tell the good earnings surprises from the not-so-good ones? Look at sales. A company that's ringing the register more has better momentum than one that's merely cutting costs. Also, studies show that instances of numbers massaging are higher among companies that miss sales forecasts but beat earnings estimates.

Jegadeesh and Livnat looked at earnings announcements from 1987 to 2003 and assumed stocks were bought a day after the news hit and held for six months. The 20 percent of stocks that had the biggest positive earnings surprises beat the market by three percentage points over six months. The top 20 percent in terms of sales surprises beat by 2.6 percentage points. Zero in on companies that turn up in both groups, according to the findings, and you'll top the market's return by 5.3 percentage points over six months.

Reproducing those numbers on your own, however, might prove challenging. The study doesn't account for commissions, a significant hit considering you'd have to make hundreds of trades a quarter. Also, not all stock-screening tools allow you to search for sales surprises. I used a tool from Reuters Research. It's powerful but pricey, at $40 a month or $300 a year. Still, the broad implications of the study are plenty useful. No matter what kind of stock-picking strategy you use, you might be able to improve it by looking for recent upside-earnings and revenue surprises.

The nine companies in the table above topped earnings and sales estimates by at least 10 percent each in their most recent quarterly reports. They have manageable debt levels and price-to-earnings/growth ratios below 1.5, which means each stock looks cheaper than the broad market relative to its earnings growth forecast. Alliance Data takes on other companies' busy work. When you sign up for a store credit card, such as those issued by The Limited, your account is really managed by Alliance Data. The company also processes payments for utilities, manages miles programs for airlines, and sends out statements and customer letters for just about anyone. Arch Coal is the nation's second-largest producer of that increasingly popular energy source. About half of the nation's electricity comes from coal, and worldwide demand for the stuff is up as oil and gas remain expensive by comparison. CompuCredit specializes in using computer models to find people whose credit is marred but who nonetheless are likely to pay their bills on time. It uses this information to issue credit cards and to buy and manage portfolios of receivables from other companies. The company is also expanding into auto finance and what it calls "micro loans" really just payday loans.

Comtech Telecommunications makes satellite gear and "over the horizon" transmitters, a low-cost satellite alternative that bounces signals off the atmosphere, for private industry and the military. Its sales have increased tenfold since 1998. Drew Industries makes components for recreational vehicles and manufactured homes. High gas prices have dampened sales of the largest motor homes, but there's strong demand for the towable RVs that are Drew's specialty. Global Industries builds pipelines and platforms for offshore oil and gas drillers. Energy companies lay pipelines about two years after completing wells, so Global is just now seeing soaring demand related to a ramp-up in drilling in 2004.

Mueller Industries makes and sells plumbing fixtures and fittings to retailers and wholesale distributors. Its profit has doubled in two years on strong commercial and residential building activity. SEI Investments handles everything but the schmoozing and stock picking for money managers and financial advisers accounting, administration and more. And it provides financial planning for wealthy investors. Finally, West Pharmaceutical Services makes things like syringes, inhalers and drug containers. It's benefiting from a shift to higher-margin products like tamper-resistant seals for injectable medicines.