BY MURRAY COLEMAN (Investor's Business Daily)

A little dose of good news can give a big bounce to small-cap stocks.

Then again, just the opposite can happen.

Tracking earnings surprises in small-cap markets is something Zacks Investment Research has been doing for nearly 25 years. On Thursday, a new exchange traded fund is set to become available to take advantage of this data.

The PowerShares Zacks Small Cap Portfolio (PZJ) will trade on the American Stock Exchange. It will be based on a proprietary index Zacks has offered to institutional traders for the past decade.

But how trusty are earnings surprises as a way to invest in a fund?

"It's not gimmicky at all. There are a lot of active managers who use the same sort of approach to guide their mutual funds," said Dan Culloton, a senior ETF analyst at Morningstar.

Wait and See

Bruce Zaro, chief market strategist at Delta Global Advisors, agrees. "The smaller-cap markets are where earnings surprises happen the most and have the biggest impact," he said. "So it could be a very sound strategy depending on how much history they consider."

Both are taking a wait-and-see attitude, though. As a matter of routine, neither will advise investors to jump into a fund without much in the way of a performance history.

The benchmark uses data going back to 1982. Mitch Zacks, a portfolio manager and son of the firm's founder, says research shows that from then through 2005:

• If a firm hasn't produced a positive earnings surprise in the last four quarters, it has a 32% chance of doing so in the upcoming quarter.

• If it has beaten expectations in the last four quarters, those chances rise to 74%.

"So a company is almost 2.5 times more likely to report an earnings surprise in the next quarter if it has outperformed very recently," said Zacks.

Equal Weight

The ETF's benchmark takes into account liquidity and number of analysts covering a name.

"We focus on the magnitude of earnings surprises in the most recent quarter," said Zacks. "For those names reporting very strong results, we've found that positive performance tends to last three or four quarters."

The fund will equal-weight its assets among 250 names. That represents about 10% of the small-cap universe. At the same time, it keeps sector weightings in line with the Russell 2000 index. The fund tracking that market-cap weighted benchmark, the iShares Russell 2000 Index Fund, (IWM) is the fourth most popular ETF based on trading volume, says Morningstar.

This year heading into Monday, the Russell ETF was up 6.68%. Zacks says if it had been trading, its new ETF would've returned 7.36%. Back-tested data show it outperforming by wide margins over one, three, five and 10 years.

"The equal-weighting strategy gives us a little smaller average market weight than the Russell 2000 index," said Zacks. "In our index, the bottom 10 names and the top 10 holdings get the same weight."