Zacks Investment Research

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Zacks Investment Research is an independent U.S. investment research firm best known for its consensus earnings estimates and the Zacks Rank, a quantitative rating that places stocks on a 1 to 5 scale based on how Wall Street analysts are revising their earnings forecasts. Len Zacks founded the company in 1978, building on ideas he developed while working toward a Ph.D. at MIT. Zacks sells data, research reports, ratings and screening tools to individual investors and to professional investors who manage their own and clients’ money.

How Zacks Investment Research Works

Zacks is an aggregator first. According to the company, it collects electronic data feeds and printed research every day from 185 brokerage firms, covering more than 8,500 publicly traded North American companies. Combining the forecasts of thousands of sell-side analysts produces a consensus estimate for each company’s earnings per share (EPS), and the firm built its reputation on this consensus data.

The ratings sit on top of that data. Rather than asking what analysts think a stock is worth, the Zacks model watches how their EPS forecasts change. When analysts raise their estimates, Zacks reads it as new information about a company’s earnings power that the share price may not yet fully reflect.

The four factors behind the Zacks Rank

Zacks scores each stock on four earnings-related inputs:

• Agreement: how far analysts are moving in the same direction when they revise their estimates.
• Magnitude: the size of the recent change in the consensus estimate.
• Upside: the gap between Zacks’ own estimate of the change and the consensus estimate.
• Surprise: whether the company has reported positive earnings surprises (actual results above the consensus) over the last few quarters.

The scores are combined into a single grade, and stocks are sorted into five groups:

Interpreting the Zacks Rank

The scale runs opposite to many rating systems, including star ratings, where five is best. In the Zacks system, #1 is the top rating. A stock moving from #3 to #2 has been upgraded, not downgraded.

Zacks explains the reasoning behind the model this way: when estimates rise, institutional investors tend to add to their positions, and that buying supports the price. Because large funds build positions gradually, an individual investor who acts on the revision signal early may benefit from the anticipated price move. The rank is framed around a short horizon. It describes the earnings revision picture now, and it can change as new revisions arrive.

Ranks Beyond Individual Stocks

Zacks Industry Rank. This is the average Zacks Rank of all the companies in a given industry. A strong industry rank indicates that estimates are rising broadly across the group, which can point to conditions favoring the whole industry rather than a single company.

Zacks Mutual Fund Rank. Zacks’ Quantitative Research Department calculates this rating quarterly for about 19,000 mutual funds. It draws on the average Zacks Rank of the stocks each fund holds, along with other quantitative factors.

Zacks ETF Rank. This rating aims to identify exchange-traded funds with a favorable one-year outlook. It uses a range of quantitative measures, such as expense ratio, momentum, yield and the holdings inside each ETF.

Zacks Stock Screener. The screener is a paid tool that filters stocks by metrics such as price change, dividends and returns, as well as by Zacks Rank and changes in EPS estimates. It works like any stock screener, with the firm’s proprietary ratings added as filter fields. Premium Screens come with a paid premium membership, and higher-priced tiers add more tools. Zacks offers both free and paid content, with access expanding at each tier.

Example of Zacks Investment Research

Zacks publishes its own case studies. In one, LSB Industries received a Strong Buy rating in July 2012 because analysts had been raising their earnings estimates and the model expected more upgrades. Over the following three months, with further upward revisions, the stock gained 36%, compared with 5% for the S&P 500, according to the company. This is a single example chosen by Zacks to illustrate the model. It does not show how often Strong Buy stocks perform this way.

Hypothetical example of the mechanics. Assume a company’s consensus EPS estimate for the current year is $2.00, based on 10 analysts. Over a month, seven analysts raise their estimates and none lower them, and the consensus rises to $2.20. The company also beat estimates in each of its last two quarters. In Zacks’ terms, agreement is high (seven of seven revisions point up), magnitude is a 10% rise in the consensus, and the surprise history is positive. Inputs like these push a stock toward the top of the scale. If the same analysts later cut their numbers back toward $2.00, the inputs reverse and the rank would be expected to fall, whatever the stock’s valuation or long-term prospects.

The example shows what the rank does not measure. A stock with a high P/E ratio can still earn a #1 rank if estimates are climbing, and a cheap stock can rank #5 if estimates are falling.

Zacks vs. Morningstar

Zacks is often compared with Morningstar, the Chicago-based research firm known for its mutual fund and ETF data. Both publish research, both rate investments on a five-level scale, and both sell free and paid tiers. Their methods differ:

• Zacks is quantitative and forward-looking in a narrow sense: its ratings respond to changes in analysts’ earnings forecasts. Its fund ranks are built largely from the ranks of the stocks the fund holds.
• Morningstar puts more weight on fundamental analysis. Its well-known star rating uses a proprietary formula based on a fund’s past performance relative to other funds in its category.

A fund can therefore look attractive in one system and average in the other, because the two systems measure different things: recent estimate momentum versus historical risk-adjusted performance and fundamental research.

Limitations of Zacks Investment Research

The performance figures are the company’s own. Zacks states that its #1 Strong Buy stocks have generated average annual returns above 25% and beat the S&P 500 in 26 of 30 years. These are the firm’s reported results for a model portfolio. They do not include an individual investor’s trading costs, taxes, timing or position sizing, and past results do not guarantee future returns.

It depends on analyst forecasts. The model can only be as informative as the estimates it aggregates. Sell-side analysts can move together, change their numbers late, or miss events entirely. Zacks argues that analysts tend to revise conservatively, so revisions carry signal, but a signal built on forecasts inherits their errors.

It is a short-term measure. The rank tracks earnings revision momentum. It says little about balance sheet strength, competitive position, management quality or whether a stock’s price is reasonable relative to its long-run value. A long-term investor using the rank alone would be ignoring most of what determines a business’s value over many years.

Ratings change. A rank reflects conditions at a point in time. A Strong Buy can become a Hold within weeks as revisions slow, which can lead to frequent trading for anyone who follows the ratings mechanically.

Quantitative does not mean bias-free in every sense. The model removes individual analysts’ preferences from the final rating, but the underlying estimates still come from human analysts, and the choice of factors and weights is Zacks’ own design.

Common Points of Confusion

Zacks Rank vs. analyst recommendations. A brokerage’s “buy” rating is an opinion about a stock. A Zacks Rank is a score derived from how analysts’ EPS estimates are changing. A stock can carry many analyst buy ratings and still rank poorly if those analysts are cutting their earnings forecasts.

Zacks Rank vs. consensus estimate. The consensus estimate is a number, such as expected EPS for the year. The rank is a grade based on how that number and its components are moving.

#1 vs. #5. On Zacks’ scale, #1 is the strongest rating and #5 the weakest.

The Bottom Line

The Zacks Rank matters most to investors who want a short-term signal built on how analysts are revising their earnings forecasts. It can flag stocks and industries where estimates are rising, but it says little about valuation, balance sheet strength or long-term prospects, and its reported returns come from the firm's own model portfolio. Long-term investors are better served using the rank as one input alongside fundamental research.