Post Loss/Profit Announcement Drift

We document a market failure to fully respond to loss/profit quarterly announcements. The annualized post portfolio formation return spread between two portfolios formed on extreme losses and extreme profits is approximately 21 percent. This loss/profit anomaly is incremental to previously documented accounting-related anomalies, and is robust to alternative risk adjustments, distress risk, firm size, short sales constraints, transaction costs, and sample periods. In an effort to explain this finding, we show that this mispricing is related to differences between conditional and unconditional probabilities of losses/profits, as if stock prices do not fully reflect conditional probabilities in a timely fashion.

[1]  Patricia M. Dechow,et al.  The Persistence and Pricing of the Cash Component of Earnings , 2006 .

[2]  Terence Lim,et al.  Bad News Travels Slowly: Size, Analyst Coverage and the Profitability of Momentum Strategies , 1998 .

[3]  Mary E. Barth,et al.  Relative valuation roles of equity book value and net income as a function of financial health , 1998 .

[4]  A. Tversky,et al.  On the psychology of prediction , 1973 .

[5]  Kent D. Daniel,et al.  Investor Psychology in Capital Markets: Evidence and Policy Implications , 2001 .

[6]  S. Basu,et al.  Investment Performance of Common Stocks in Relation to their Price-Earnings Ratios , 1977 .

[7]  Victor L. Bernard,et al.  POST-EARNINGS-ANNOUNCEMENT DRIFT - DELAYED PRICE RESPONSE OR RISK PREMIUM , 1989 .

[8]  Richard G. Sloan.  Do Stock Prices Fully Reflect Information in Accruals and Cash Flows About Future Earnings , 1998 .

[9]  J. B. Heaton,et al.  Competing Theories of Financial Anomalies , 2001 .

[10]  E. Fama,et al.  Risk, Return, and Equilibrium: Empirical Tests , 1973, Journal of Political Economy.

[11]  Jeffrey Hales,et al.  Predicting the Next Step of a Random Walk: Experimental Evidence of Regime-Shifting Beliefs , 2001 .

[12]  E. Fama,et al.  Forecasting Profitability and Earnings , 1999 .

[13]  Mark M. Carhart.  On Persistence in Mutual Fund Performance , 1997 .

[14]  Daniel W. Collins,et al.  Equity Valuation and Negative Earnings: The Role of Book Value of Equity , 1999 .

[15]  P. Elgers,et al.  Reductions In Analysts Annual Earnings Forecast Errors Using Information In Prior Earnings And Security Returns , 1994 .

[16]  Kenneth S. Lorek,et al.  The relationship between time-series models and the security market's expectation of quarterly earnings , 1984 .

[17]  L. Brown.  A Temporal Analysis of Earnings Surprises: Profits Versus Losses , 2001 .

[18]  Nicholas Barberis,et al.  A Model of Investor Sentiment , 1997 .

[19]  W. J. Conover,et al.  Practical Nonparametric Statistics , 1972 .

[20]  Josef Lakonishok,et al.  Contrarian Investment, Extrapolation, and Risk , 1993 .

[21]  Carla K. Hayn.  The information content of losses , 1995 .

[22]  E. Fama,et al.  Common risk factors in the returns on stocks and bonds , 1993 .

[23]  Tyler Shumway.  The Delisting Bias in CRSP Data , 1997 .

[24]  Sudipta Basu,et al.  Loss Firms and Analysts' Earnings Forecast Errors , 1996 .

[25]  A. Tversky,et al.  Intuitive Prediction: Biases and Corrective Procedures , 1982 .

[26]  H. Simon,et al.  Models of Man. , 1957 .

[27]  Tyler Shumway.  Forecasting Bankruptcy More Accurately: A Simple Hazard Model , 1999 .

[28]  Kalok Chan,et al.  Structural and Return Characteristics of Small and Large Firms , 1991 .

[29]  Ilia D. Dichev,et al.  Earnings, Adaptation, and Equity Value , 1996 .

[30]  Daniel W. Collins,et al.  Changes in the value-relevance of earnings and book values over the past forty years , 1997 .

[31]  Susan G. Watts,et al.  Bankruptcy classification errors in the 1980s: An empirical analysis of Altman's and Ohlson's models , 1996 .

[32]  D. Hirshleifer.  Investor Psychology and Asset Pricing , 2001 .

[33]  D. Collins,et al.  Errors in Estimating Accruals: Implications for Empirical Research , 1999 .

[34]  S. Basu.  The relationship between earnings' yield, market value and return for NYSE common stocks: Further evidence , 1983 .

[35]  S. P. Kothari,et al.  The Effect of International Institutional Factors on Properties of Accounting Earnings , 1999 .

[36]  E. Fama,et al.  Financing Decisions: Who Issues Stock? , 2004 .

[37]  D. Collins,et al.  Errors in Estimating Accruals: Implications for Empirical Research , 1999 .

[38]  Lawrence D. Brown,et al.  Univariate Time-Series Models of Quarterly Accounting Earnings per Share: A Proposed Model , 1979 .

[39]  Kent D. Daniel,et al.  A Theory of Overconfidence, Self-Attribution, and Security Market Under- and Over-Reactions , 1997 .

[40]  Ilia D. Dichev.  Is the Risk of Bankruptcy a Systematic Risk , 1998 .

[41]  M. W. Nelson,et al.  Experimental Research in Financial Accounting , 2001 .

[42]  D. Hirshleifer,et al.  Limited Attention, Information Disclosure, and Financial Reporting , 2003 .

[43]  Ross L. Watts,et al.  SOME TIME SERIES PROPERTIES OF ACCOUNTING INCOME , 1972 .

[44]  Daniel Kahneman,et al.  Availability: A heuristic for judging frequency and probability , 1973 .

[45]  Suresh Radhakrishnan,et al.  Investor Sophistication and Patterns in Stock Returns after Earnings Announcements , 2000 .

[46]  Kent D. Daniel,et al.  Presentation Slides for 'Investor Psychology and Security Market Under and Overreactions' , 1998 .

[47]  L. Brown,et al.  A Temporal Analysis of Quarterly Earnings Thresholds: Propensities and Valuation Consequences , 2005 .

[48]  E. Fama,et al.  Multifactor Explanations of Asset Pricing Anomalies , 1996 .

[49]  Edward I. Altman,et al.  FINANCIAL RATIOS, DISCRIMINANT ANALYSIS AND THE PREDICTION OF CORPORATE BANKRUPTCY , 1968 .

[50]  V. Bernard,et al.  Evidence that stock prices do not fully reflect the implications of current earnings for future earnings , 1990 .

[51]  W. Beaver,et al.  Delisting Returns and Their Effect on Accounting-Based Market Anomalies , 2006 .

[52]  M. W. Nelson,et al.  Experimental Research in Financial Accounting , 2001 .

[53]  Conservatism and Cross-Sectional Variation in the Post-Earnings-Announcement-Drift , 2003 .

[54]  R. Zeckhauser,et al.  Earnings Management to Exceed Thresholds , 1999 .

[55]  W. Beaver,et al.  Do Stock Prices of Property Casualty Insurers Fully Reflect Information about Earnings, Accruals, Cash Flows, and Development? , 2001 .

[56]  D. Collins,et al.  Earnings-Based and Accrual-Based Market Anomalies: One Effect or Two? , 1999 .

[57]  K. Subramanyam,et al.  Does the Stock Market Underreact to Going Concern Opinions? Evidence from the U.S. and Australia , 2006 .

[58]  R. Ball,et al.  How Naive Is the Stock Market's Use of Earnings Information? , 1996 .

[59]  Sofus A. Macskassy,et al.  More than Words: Quantifying Language to Measure Firms' Fundamentals the Authors Are Grateful for Assiduous Research Assistance from Jie Cao and Shuming Liu. We Appreciate Helpful Comments From , 2007 .

[60]  Kent D. Daniel,et al.  Overconfidence, Arbitrage, and Equilibrium Asset Pricing , 2001 .

[61]  L. Brooks,et al.  FURTHER EVIDENCE OF THE TIME SERIES PROPERTIES OF ACCOUNTING INCOME , 1976 .

[62]  Ravi Bhushan,et al.  An informational efficiency perspective on the post-earnings announcement drift , 1994 .

[63]  Sheridan Titman,et al.  On Persistence in Mutual Fund Performance , 1997 .

[64]  Adam V. Reed,et al.  Stocks are Special Too: An Analysis of the Equity Lending Market , 2002 .

[65]  Ian D. Gow,et al.  Correcting for Cross-Sectional and Time-Series Dependence in Accounting Research , 2009 .

[66]  Dennis E. Logue,et al.  Foundations of Finance. , 1977 .

[67]  Mozaffar Nayim Khan.  Are Accruals Mispriced? Evidence from Tests of an Intertemporal Capital Asset Pricing Model , 2008 .

[68]  P. Kline.  Models of man , 1986, Nature.

[69]  L. Brown,et al.  Do Stock Prices Fully Reflect the Implications of Current Earnings for Future Earnings for Ar1 Firms? , 2000 .

[70]  Ross L. Watts,et al.  TIME-SERIES OF ANNUAL ACCOUNTING EARNINGS , 1977 .

[71]  Ilia D. Dichev,et al.  Earnings Management to Avoid Earnings Decreases and Losses , 1997 .

[72]  E. Fama,et al.  Disappearing Dividends: Changing Firm Characteristics or Lower Propensity to Pay? , 2000 .