There is considerable academic research focused on effect of earnings. A research published in 2005 shows that companies that report large positive earnings surprises continue to outperform the market and beat analysts' expectations up to three years later.Firms that report a large positive earnings surprise do much better than expected. The researchers found that in subsequent years, firms with extremely good earnings tend to have persistent earnings surprises in the same direction, strong growth in cash flows and earnings. A portfolio of such stocks outperforms the market.
The Extreme Future Stock Returns Following Extreme Earnings Surprises
We investigate the stock returns subsequent to quarterly earnings surprises, where the benchmark for an earnings surprise is the consensus analyst forecast. By defining the surprise relative to an analyst forecast rather than a time-series model of expected earnings, we document returns subsequent to earnings announcements that are much larger, persist for much longer, and are more heavily concentrated in the long portion of the hedge portfolio than shown in previous studies. We show that our results hold after controlling for risk and previously documented anomalies, and are positive for every quarter between 1988 and 2000. Finally, we explore the financial results and information environment of firms with extreme earnings surprises and find that they tend to be "neglected" stocks with relatively high book-to-market ratios, low analyst coverage, and high analyst forecast dispersion. In the three subsequent years, firms with extreme positive earnings surprises tend to have persistent earnings surprises in the same direction, strong growth in cash flows and earnings, and large increases in analyst coverage, relative to firms with extreme negative earnings surprises. We also show that the returns to the earnings surprise strategy are highest in the quartile of firms where transaction costs are highest and institutional investor interest is lowest, consistent with the idea that market inefficiencies are more prevalent when frictions make it difficult for large, sophisticated investors to exploit the inefficiencies.
There are many ways to trade earnings and over the long run the price of stock depends on earnings growth.
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