Analyst Forecasts and the Cross Section of European Stock Returns

We examine revisions to earnings forecasts by equity analysts and their role in predicting stock returns. We provide evidence that European stocks with net upward revised forecasts earn higher future returns than otherwise similar stocks. This effect is not concentrated in small stocks, stocks with low analyst coverage, or stocks with low book‐to‐market ratios. We find differences in the return continuation patterns of stocks with upward versus downward revisions, namely, bad news travels quickly, but good news travels slowly. This result is consistent with investors' attaching greater significance to poor earnings forecasts, but adopting a wait‐and‐see approach to good news.     

Earnings forecasts and idiosyncratic volatilities

We test the theoretical relation between idiosyncratic return volatilities and the volatilities of cash-flow news based on the expected returns on equity (ROE) for CRSP stocks over the period 1977–2008. Consistent with economic intuition, we find that using analyst forecasts of earnings is superior to using realized earnings to proxy for market expectations about future cash flow news. Our findings are consistent with a market where stock return volatilities are positively and asymmetrically related to changes in the volatilities of expectations for a fundamental driver of cash flow news (ROE). Our findings are robust after correcting for forecast biases, various fundamental variables, newly-listed and mature firms, and periods with and without earnings announcements.     

Abnormal returns to investment strategies based on the timing of earnings reports

This paper adds to recent evidence on market inefficiency in processing information in earnings reports. It documents that short positions taken in sample stocks which did not report earnings by the date expected during the sample period, 1971–1976, would have been abnormally profitable, before transaction costs. This is because late reports, on average, revealed bad news which was not anticipated in market prices prior to the report date. The magnitude of the average abnormal returns is in the order of 1.0% over 20 days but is larger for smaller firms in the sample and positively related to the length of the reporting delay. The paper also documents that long positions taken in stocks reporting early with good news would have generated abnormal returns of approximately 1.0% on average over a 20-day holding period.     

Dispersion in Analyst Forecasts and the Profitability of Earnings Momentum Strategies

This paper shows that the dispersion in analysts' consensus forecasts contains incremental information to predict future stock returns. Consistent with prior research, stock prices in the German market underreact to news about future earnings and drift in the direction suggested by analysts' forecasts revisions. Even higher abnormal returns can be achieved by applying such an earnings momentum strategy to stocks with a low dispersion in analyst forecasts. These results support one of the recent behavioural models in which investors underweight new evidence and conservatively update their beliefs in the right direction, but by too little in magnitude with respect to more objective information.     

Aggregate Market Reaction to Earnings Announcements

This analysis identifies a distinct immediate announcement period negative relation between earnings announcement surprises and aggregate market returns. Such a relation implies that market participants use earnings information in forming expectations about expected aggregate discount rates and, specifically, that good earnings news is associated with a positive shock to required returns. Consistent with this interpretation we find that Treasury bond rates and implied future inflation expectations respond directly to earnings news. We also find some evidence that the negative relation between earnings news and market return persists beyond the immediate announcement period, suggesting that market participants do not immediately fully impound these future market return implications of aggregate earnings news.     

Sell‐Side Analyst Research and Stock Comovement

We document that a stock's price around a recommendation or forecast covaries with prices of other stocks the issuing analyst covers. The effect of shared analyst coverage on stock price comovement extends beyond analyst activity days. A stock's daily returns covary with the returns of other stocks with which it shares analyst coverage. These links between stock price comovement and shared analyst coverage are consistent with the coverage‐specific information we find in earnings forecasts; analysts who cover both stocks in a pair expect future earnings of the stocks to be more highly correlated than do analysts who cover only one stock from the pair. Collectively, our evidence indicates that analyst research produces coverage‐specific spillovers that raise price comovement among stocks that share analyst coverage. The strength of these spillovers is comparable to spillovers from broad industry and market information in analyst research.     

When is a MAX not the MAX? How news resolves information uncertainty

A well-known asset pricing anomaly, the “MAX” effect, measured by the maximum daily return in the past month, depicts stocks’ lottery-like features and investor gambling behaviour. Using the comprehensive stock-level Dow Jones (DJNS) news database between 1979 and 2016, we consider in a empirical setting how the presence of news reports affects these lottery-type stocks. We find an augmented negative relationship between MAX stocks without news and expected returns, whereby MAX with news coverage generates return momentum. The differing future return relationships between MAX stocks with and without news appears to be best explained by information uncertainty mitigation upon news arrival. Overall, our findings suggest that news plays a role in resolving information uncertainty in the stock market.     

Expectations and the Cross-Section of Stock Returns

Previous research has shown that stocks with low prices relative to book value, cash flow, earnings, or dividends (that is, value stocks) earn high returns. Value stocks may earn high returns because they are more risky. Alternatively, systematic errors in expectations may explain the high returns earned by value stocks. I test for the existence of systematic errors using survey data on forecasts by stock market analysts. I show that investment strategies that seek to exploit errors in analysts' forecasts earn superior returns because expectations about future growth in earnings are too extreme.     

Earnings Announcements,Differences of Opinion and Management Guidance

Berkman, Dimitrov, Jain, Koch, and Tice (2009) document a negative relationship between differences of opinion and earnings announcement returns, and this relationship is more pronounced when short‐sale constraints are likely to be high. These findings are interpreted as support for the theory in Miller (1977) that binding short sale constraints cause pessimists to be underrepresented in price formation. We conjecture that accounting information (i.e., earnings news) is likely to play a role in this returns pattern. After controlling for the level of earnings news, we find that the relationship between differences of opinion and stock returns is either eliminated or opposite from what is predicted by Miller's theory. Further, we present evidence that suggests the confounding effect of earnings news can be explained by (pessimistic) management earnings guidance. Our findings offer an alternative explanation for why low differences of opinion stocks earn greater abnormal returns around earnings announcements.     

Stock returns,aggregate earnings surprises,and behavioral finance

We study the stock market's reaction to aggregate earnings news. Prior research shows that, for individual firms, stock prices react positively to earnings news but require several quarters to fully reflect the information in earnings. We find a substantially different pattern in aggregate data. First, returns are unrelated to past earnings, suggesting that prices neither underreact nor overreact to aggregate earnings news. Second, aggregate returns correlate negatively with concurrent earnings; over the last 30 years, for example, stock prices increased 5.7% in quarters with negative earnings growth and only 2.1% otherwise. This finding suggests that earnings and discount rates move together over time and provides new evidence that discount-rate shocks explain a significant fraction of aggregate stock returns.     

Short Interest,Returns, and Unfavorable Fundamental Information

Several months before information becomes public, the level of short interest contains value‐relevant information about publicly traded corporations. Short interest predicts future bad news, negative earnings surprises, and downward revisions in analyst earnings forecasts. This informational content is stronger for stocks that are harder to short. We also find that nearly half of the well‐known cross‐sectional relation between short interest and future stock returns is related to future changes in firms’ value‐relevant information. Our results suggest that short interest predicts future returns, in part, due to short sellers’ ability to uncover unfavorable information about firms.     

Anticipated Earnings Announcements and the Customer–Supplier Anomaly

I test whether the anticipation of earnings news stimulates acquisition of customer information and mitigates returns to the customer–supplier anomaly documented by Cohen and Frazzini (“Economic Links and Predictable Returns.” The Journal of Finance 63 (2008): 1977–2011). I find that attention to a firm's publicly disclosed customers increases shortly before the firm announces earnings, and that customer stock returns predict supplier stock returns shortly before, but not after, the supplier's earnings announcement. I further find some evidence that these predictable returns are increasing in the level of customer information acquisition. These results are unique to anticipated disclosure events and suggest that anticipation of supplier earnings announcements resolves investor limited attention to customer information and accelerates price discovery of customer news.     

Does news play an important role in the correction process of the accrual anomaly?

We examine whether the financial press plays an important role in the correction of the accruals anomaly. Using 83,016 Wall Street Journal news articles published during 1993–2006, we find that a significant fraction of abnormal returns associated with the accruals trading strategy is concentrated on news days. The clustering of returns on news announcements is consistent with the financial press revealing information valuable for the correction of accruals mispricing. Further, we find that earnings‐related news is more influential in the correction process than non‐earnings‐related news. Collectively, the results suggest that the financial press provides useful information to capital market participants.     

Price and earnings momentum: An explanation using return decomposition

We explain price and earnings momentum by investigating dynamics of cash flow (CF) news and discount rate (DR) news. We find that before the holding period, winners experience higher DR news than losers, which makes winners display lower ex-ante expected returns than losers. Momentum returns come from the persistently higher CF news for winners as compared to losers both before and during the holding periods. The evidence favors a behavioral explanation that the market incorporates cash flow information too slowly, which drives momentum returns. In addition, we find that the DR news, in particular that of the momentum losers, drives the time-series profitability of momentum strategies. Furthermore, by comparing price momentum with earnings momentum, we show that the relative load on past CF news as compared to past DR news affects long-run portfolio performance.     

Earnings Announcements and Systematic Risk

Firms scheduled to report earnings earn an annualized abnormal return of 9.9%. We propose a risk‐based explanation for this phenomenon, whereby investors use announcements to revise their expectations for nonannouncing firms, but can only do so imperfectly. Consequently, the covariance between firm‐specific and market cash flow news spikes around announcements, making announcers especially risky. Consistent with our hypothesis, announcer returns forecast aggregate earnings. The announcement premium is persistent across stocks, and early (late) announcers earn higher (lower) returns. Nonannouncers' response to announcements is consistent with our model, both over time and across firms. Finally, exposure to announcement risk is priced.     

Aggregate Earnings and Corporate Bond Markets

I examine the previously unexplored relation between aggregate earnings changes and corporate bond market returns. I find that aggregate earnings changes have a negative relation to investment‐grade corporate bond market returns and a positive relation to high‐yield corporate bond market returns. The aggregate earnings‐returns relation is lower (i.e., less positive or more negative) for bonds with higher credit ratings and longer maturities. Further, I show that the aggregate earnings‐returns relation is driven by both the expected and the news component of aggregate earnings changes. The expected component is negatively related to expected returns, and the news component is positively related to cash flow news and changes in nominal interest rates, and negatively related to changes in default premia. My results contribute to the understanding of the role of earnings in corporate bond markets as well as the macroeconomic role of accounting information.     

Bringing the Future Forward: The Effect of Disclosure on the Returns-Earnings Relation

This paper studies how firm disclosure activity affects the relation between current annual stock returns, contemporaneous annual earnings and future earnings. Our results show that firms with relatively more informative disclosures "bring the future forward" so that current returns reflect more future earnings news. We also find that changes in disclosure activity are positively related to changes in the importance of future earnings news for current returns. These results suggest that a firm's disclosure activity reveals credible, relevant information not in current earnings, and that this information is incorporated into the current stock price.     

Can financial statement analysis beat consensus analysts’ recommendations?

We examine whether investors can exploit financial statement information to identify companies with a greater likelihood of future earnings increases and whether stocks of those companies generate 1-year abnormal returns that exceed the abnormal returns from following analysts’ consensus recommendations. Our approach summarizes financial statement information into a “predicted earnings increase score,” which captures the likelihood of 1-year-ahead earnings increases. We find that, within our sample of consensus recommendations, stocks with high scores are much more likely to experience future earnings increases than stocks with low scores. A hedge portfolio strategy that utilizes our approach within each consensus recommendation level generates average annual abnormal returns of 10.9 percent over our 12-year sample period, after controlling for previously identified risk factors. These abnormal returns exceed those available from following analysts’ consensus recommendations. Our results show that share prices and consensus recommendations fail to impound financial statement information that helps predict future earnings changes.     

Individual Investor Trading and Return Patterns around Earnings Announcements

This paper provides evidence of informed trading by individual investors around earnings announcements using a unique data set of NYSE stocks. We show that intense aggregate individual investor buying (selling) predicts large positive (negative) abnormal returns on and after earnings announcement dates. We decompose abnormal returns following the event into information and liquidity provision components, and show that about half of the returns can be attributed to private information. We also find that individuals trade in both return‐contrarian and news‐contrarian manners after earnings announcements. The latter behavior has the potential to slow the adjustment of prices to earnings news.     

An Analysis of Contrarian Investment Strategies in the UK

The performance of contrarian, or value strategies – those that invest in stocks that have low market value relative to a measure of their fundamentals – continues to attract attention from researchers and practitioners alike. While there is much extant evidence on the profitability of value strategies, however, most of this evidence pertains to the US. In this paper, we provide a detailed characterisation of value strategies using data on UK stocks for the period 1975 to 1998. We first undertake simple one-way and two-way classifications of stocks in which value is defined using both past performance and expected future performance. Using sales growth as a proxy for past performance and book-to-market, earnings yield and cash flow yield as measures of expected future performance, we find that that stocks that have both poor past performance and low expected future performance have significantly higher returns than those that have either good past performance or good expected future performance. Allowing for size effects in returns reduces the value premium but it nevertheless remains significant. We go on to explore whether the profitability of value strategies in the UK can be explained using the three factor model of Fama and French (1996). Broadly consistent with the results for the US, we find that using the one-way classification the excess returns to almost all value strategies can be explained by their loading on the market, book-to-market and size factors. However, in contrast with the US, using the two-way classification there are excess returns to value strategies based on book-to-market and sales growth, even after controlling for their loading on the market, book-to-market and size factors.