5 Rising Stocks to Sell Short Before Earnings

State Street’s earnings have exceeded expectations in 19 of the past 20 quarters, but the stock has fallen eight times. (Vanessa Leroy/Bloomberg)

Key Points

• The S&P 500 has risen 14% this year, indicating high market expectations for future profits across all 11 sectors.
• Trivariate Research identified Interactive Brokers, Marsh & McLennan, CSX, Bank OZK, and State Street as potential short-sell candidates.
• State Street’s stock fell 7.3% after its last earnings beat, demonstrating that exceeding estimates doesn’t guarantee stock gains.

Buying stocks ahead of earnings isn’t the only way to benefit from the current profit-reporting season. Plenty of names look ready to drop after they report their third-quarter financial results.

Hunting those stocks out makes sense now more than at most points because the stock market has already rallied so much. The S&P 500 is up 14% this year, in a gain that has included all 11 sectors.

When stocks rally, that reflects expectations for larger future profits, which means shares can slide if a company does anything but report results that beat estimates by a large amount. Even beating estimates by a little bit is often not enough. Earnings season is when the rubber hits the road, and companies either produce results strong enough to lift their stocks, or fail to do so.

Betting against a stock, or shorting it, is a way to benefit when stocks slide. A trader borrows someone else’s shares, immediately sells them, and then must buy them back and return them, usually within six months. The hope for the short seller is to buy the shares back at a lower price than the initial sale, creating a profit.

Trivariate Research founder Adam Parker screened for stocks to sell short before the companies report their earnings. He looked for names that have outperformed their industry peers in the past two weeks because that is a sign that the market’s expectations for their earnings are rising. More positive expectations make it harder for companies to provide stronger results than investors have penciled in.

One company that came up was Interactive Brokers , which outperformed peers by almost 7 percentage points for the two weeks leading into Tuesday. Parker also listed insurance broker and professional-services company Marsh & McLennan and railroad CSX , which have outperformed by 3.8 points and 1.9 points, respectively. A fourth company, Bank OZK, the regional lender formerly known as Bank of the Ozarks, had outperformed peers by about 1.4 percentage points over the two weeks through Tuesday.

Marsh reports its results before the market opens on Thursday, while the others are scheduled to disclose their numbers after the close. Marsh, CSX, and Interactive Brokers declined to comment, while Bank OZK didn’t immediately reply to a request for comment.

Another company Parker cited is the bank and asset manager State Street , which outperformed by 2.2 points over the two weeks through Tuesday and was up another 0.8% Wednesday morning. The stock is up 17% this year.

That performance means gains may be hard to come by even if earnings, scheduled for release before the open on Friday, surpass estimates. While State Street’s results have beaten expectations in all but one of the past 20 quarters, according to FactSet, eight of those reports produced a drop in the stock. The profits weren’t quite large enough to justify the share price.

Last quarter, earnings beat expectations, but the stock fell 7.3% the trading day after the report.

It could happen again. The company declined to comment.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com