We’re right in the middle of earnings season, which means that most mid- and large-cap companies have reported results, with small-cap stocks getting set to move into the spotlight.

#-ad_banner-#And thus far, two clear themes have emerged: Relatively few companies have been able to broadly surpass analysts’ forecasts — but one sector is building up an impressive head of steam, with strong earnings now and even stronger earnings to come.

Bad Weather — Or End Of An Era?
Of the more than 1,000 companies that have delivered quarterly results thus far, only 14 can be considered to be true “beat and raise” stocks. These are companies that not only deliver solid trailing results, but also offer solid enough guidance to lead analysts to raise their forward outlooks as well. 

Specifically, these companies have:

• Topped first-quarter earnings forecasts by at least 25%.

• Seen their 2014 and 2015 full-year profit outlooks move higher since results were released.

• Trade for less than 20 times projected 2015 profits, which is a likely cut-off point for remaining value to justify your time and energy researching them at a greater depth.

Source: Yahoo Finance

Over the past five years, we have typically seen a greater percentage of companies meet these criteria. It’s not clear if the relative dearth of “beat and raise” stocks is mostly due to lousy winter weather, or a sign that companies are no longer seeing the earnings momentum they once had.

Of these stocks, there are a few interesting story lines developing. 

First, take note of the impressive earnings momentum for biotech powerhouse Gilead Sciences (Nasdaq: GILD), which has just started selling a new hepatitis C drug that faces a robust market opportunity.  At the end of the prior earnings season, analysts thought Gilead would earn around $3.30 a share this year and $5.25 a share next year. Now, these analysts look for 2014 earnings per share (EPS) in $6 and 2015 EPS of around $7.50. That’s a remarkably large boost for a company that is already followed by more than two dozen Wall Street analysts.

You’ll also note the impressive “beat and raise” performance from financial services firm Piper Jaffray (NYSE: PJC), which is emerging as the nation’s best run mid-tier investment bank. This is the third straight impressive quarter, and forward earnings estimates for 2014 and 2015 are now significantly higher than they were when the year began.

Lastly, you’ll note that private equity firm The Blackstone Group (NYSE: BX) is the only stock in this group that is truly cheap, trading at less than 9 times projected 2015 profits. Yet despite the “beat and raise” setup, shares have actually fallen nearly 15% since mid-March. Blackstone, like Piper Jaffray, is well-positioned to capitalize on healthy equity markets. If the U.S. economy keeps strengthening, then these companies will see an increasing level of profit momentum.

My Favorite Sector
In addition to the companies in the table above, I have carved out another group of stocks that are all benefiting from solid earnings momentum and all toil in the same sector — namely, insurance.

These financial services firms are perfectly positioned for a growing economy.

First, because they tend to have more pricing power when the economy is expanding, and higher insurance premiums can flow straight to the bottom line. Second, these firms all maintain considerable cash balances and when interest rates finally start to rise, interest income is bound to explode higher. There’s reason to suspect that these “beat and raise” firms will have earnings momentum for quite some time to come.

And though insurance stocks have been moving up in recent years, they’re still fairly cheap, mostly trading for 10 to 12 times forward earnings.

These insurance stocks are now mostly trading at a slight premium to book value, which is my favorite metric for this group. If you’re looking for “below book” insurers, check out AIG (NYSE: AIG), which remains my top pick for this industry. The company’s $76 billion market value stands at a healthy discount to tangible book value of $100 million. 

First-quarter earnings are slated for release next week, and if the tone set by other insurers is any indication, then AIG should deliver solid results. Notably, AIG has topped prior earnings forecasts by at least 20% on three of the past four occasions. 

Still, the earnings backdrop for all of insurers looks quite good, and this sector represents one of the few corners of the market where you’ll find both growth and value. 

Risks to Consider: It’s important to assess the underlying reasons why a company exceeded earnings forecasts. One-time events aren’t a good enough reason to provide long-term support, and you need to find evidence of ongoing momentum in their business models.

Action to Take –> It’s clear that financial services in general, and insurers in particular, are entering into the sweet spot of their business cycle. They are all poised to gain from accelerating economic growth and almost universally trade at a discount to the broader market.

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