Millions of investors are scared about buying stocks right now -- even though now seems like a time to be more optimistic. With some small positive signs on the jobs front and improving consumer confidence, the worst might be over for the U.S. economy. If Europe doesn't blow up in the world's face, then fears of a double-dip recession could quickly disappear, setting the stage for a monumental bull market.
At least with some stocks, Wall Street analysts seem to be getting a whiff of that optimism. Even though they've recently gotten burned during the market meltdown and financial crisis, analysts have started to push upward their earnings estimates for a select group of stocks. That bodes well for those companies' prospects going forward.
Today, I want to look at the stocks from the Dow Jones Industrials (INDEX: ^DJI ) that analysts seem to like the best right now. In a moment, I'll reveal five Dow stocks that have seen the biggest increases in analysts' earnings estimates over the past three months. But first, I want to make sure that you take these numbers with an appropriate grain of salt -- because analysts don't have the best track record of making smart earnings estimates.
When pros get it wrong
Ideally, you'd be able to count on professionals who spend their entire lives looking at the stocks they follow. But doing so can be dangerous to your wealth. Patrick Cusatis and J. Randall Woolridge of Penn State University did a study a few years back that examined a 20-year swath of analysts' earnings estimates. Simply put, the results were clear: The estimates were far higher than what actually happened.
For instance, with growth rates, analysts consistently overstated figures by 4 to 6 percentage points -- a huge margin when you consider that many stocks typically post single-digit percentage growth in a typical year. The longer the forecast, the more inaccurate the prediction was. When you do the math, you see that when companies posted their actual growth, it came in 40% less than what Wall Street analysts had expected. That's a huge error -- and one that can lead to big mistakes in estimating proper valuations, especially for high-flying growth stocks.
Do upgrades matter?
The fact that analysts don't predict well may suggest that you shouldn't look at their estimates at all. But despite their inaccuracy, earnings estimates get a lot of attention from other investors, and changes to those estimates can move stock prices substantially. When analysts feel better about a stock's future prospects, investors will follow suit -- sometimes creating a self-fulfilling prophecy of share price gains, at least unless the company's actual results down the road prove them wrong.
So with that in mind, here are the five Dow stocks where analysts have ratcheted up their earnings estimates the most over the past three months.
Current EPS Estimate for 2012
Estimate 90 Days Ago
|Cisco Systems (Nasdaq: CSCO )
|Caterpillar (NYSE: CAT )
|Pfizer (NYSE: PFE )
|IBM (NYSE: IBM )
Source: S&P Capital IQ. As of Jan. 5.
In past weeks, we've already talked quite a bit about several of these stocks. Home Depot has held up well by tapping into the home-remodeling craze, in which homeowners who are essentially stuck with their homes have chosen to renovate rather than sell and move up to better homes. Caterpillar has been able to post strong earnings growth even with fears of a slowdown, upping its earnings guidance and beating estimates quarter after quarter. And even though IBM and Cisco followed much different paths in 2011 -- IBM consistently soared, while Cisco struggled early before recovering later -- any boost in the overall economy should be especially helpful for the technology sector.
That leaves Pfizer as an unexpected choice here. The company cut its dividend after making a huge acquisition in 2009 and is dealing with the same patent-cliff issues that many of its pharma peers face, having lost protection on its blockbuster Lipitor drug at the end of November. Yet the company jumped to multiyear highs recently, in part because of optimism about the company's plans to spin or sell off its nutrition and animal-health businesses. Although the $0.02 boost is minimal, it indicates that analysts like Pfizer's generic-fighting strategy -- and sees it as a potential profit-saver going forward.
Watch out below
Before you jump into any of these stocks, remember: Analysts are often wrong. Boosting estimates that may already be too high doesn't necessarily make these stocks a good buying opportunity. But if the reasons behind the moves are justified, then you'll definitely want to take a closer look.
One thing that both analysts and investors like a lot right now are dividend stocks. The Dow has plenty of dividend payers, but to get the best of the best, you have to go beyond the Dow. Let me invite you to join the thousands who've read the Fool's new free report that reveals 11 rock-solid dividend stocks for your portfolio. Don't wait, though -- it's available for only a limited time, so read it today.