Post-Earnings Announcement Drift and Related Anomalies
Since the 1970s, academics have been fascinated with the ability of earnings to predict future returns. It is well documented that stock prices drift in the direction of the earnings surprise several months after the firm announces earnings, a phenomenon referred to as post-earnings announcement drift. Post-earnings announcement drift is the topic of considerable academic research because it is at odds with an efficient market—the belief that the market quickly impounds all publicly available information into prices. Investment professionals and sophisticated investors have also become fascinated with the drift for obvious reason. At a basic level, post-earnings announcement drift implies that one can take minimal risk and beat the market by ranking stocks on the magnitude of their earnings surprises; buying those stocks at the top of the ranking and shorting those stocks at the bottom of the ranking. Although several firm characteristics are commonly thought to predict future returns (e.g., firm size, firm growth, dividend yield), earnings surprises are widely accepted as the strongest predictor, and their predictive power has survived 4 decades of academic scrutiny.1 Indeed, estimates of the returns to a long-short strategy based on taking long (short) positions in firms with extreme positive (negative) earnings surprises range from 2.84% to 6.88% per quarter (see Table 4.1).