Does the Stock Market Fully Appreciate the Implications of Leading Indicators for Future Earnings? Evidence from Order Backlog

A number of recent studies assume market efficiency and hence interpret an association between stock returns and leading indicators as evidence of the contribution of such indicators to future earnings. We explicitly examine (i) whether one leading indicator - order backlog - has predictive ability for future earnings, and (ii) whether market participants correctly incorporate such predictive ability in determining share prices. We find that the stock market overweights the contribution of order backlog in predicting future earnings and a hedge strategy that takes positions on the cross-sectional distribution of backlog generates significant future abnormal returns. Additional analysis indicates that the market mispricing is not due to analysts' inability to incorporate order backlog into their earnings forecasts.

[1]  R. Banker,et al.  An Empirical Investigation of an Incentive Plan that Includes Nonfinancial Performance Measures , 2000 .

[2]  Katherine Schipper,et al.  The Relative and Incremental Explanatory Power of Earnings and Alternative (to Earnings) Performance Measures for Returns , 2003 .

[3]  Stephen E. Wilcox.  Investor Psychology and Security Market Under- and Overreactions , 1999 .

[4]  Victor L. Bernard,et al.  CROSS-SECTIONAL DEPENDENCE AND PROBLEMS IN INFERENCE IN MARKET-BASED ACCOUNTING RESEARCH , 1987 .

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

[6]  David Burgstahler,et al.  Do Stock Prices Fully Reflect the Implications of Special Items for Future Earnings , 2002 .

[7]  Kathryn Dixon Jost.  Have Financial Statements Lost Their Relevance , 2000 .

[8]  C. Leadbetter,et al.  New Measures for the New Economy , 2000 .

[9]  W. Beaver.  The Time Series Behavior of Earnings , 1970 .

[10]  Stephen J. Brown,et al.  Use of R-Squared in Accounting Research: Measuring Changes in Value Relevance Over the Last Four Decades , 1998 .

[11]  Frederic S. Mishkin,et al.  A Rational Expectations Approach to Macroeconometrics: Testing Policy Ineffectiveness and Efficient-Markets Models. , 1984 .

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

[13]  Brett Trueman,et al.  The Eyeballs Have it: Searching for the Value in Internet Stocks , 2000 .

[14]  Brian J. Bushee,et al.  Abnormal Returns to a Fundamental Analysis Strategy , 1997 .

[15]  Frederic S. Mishkin,et al.  An Integrated View of Tests of Rationality, Market Efficiency, and the Short-Run Neutrality of Monetary Policy , 1981 .

[16]  Wayne R. Landsman,et al.  Has the Information Content of Quarterly Earnings Announcements Declined in the Past Three Decades , 2002 .

[17]  Do Analysts' Forecasts Fully Reflect the Information in Accruals? , 2001 .

[18]  Andrei Shleifer,et al.  Technology, Information Production, and Market Efficiency , 2001 .

[19]  Charles E. Wasley,et al.  Capital Markets Research in Accounting , 2001 .

[20]  Uday Chandra,et al.  The Use of Trade Association Disclosures by Investors and Analysts: Evidence from the Semiconductor Industry* , 1999 .

[21]  E. Ziegel,et al.  The Balanced Scorecard , 1998 .

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

[23]  Jeffery Abarbanell.  Differences in Commercial Database Reported Earnings: Implications for Inferences Concerning Analyst Forecast Rationality, the Association between Prices and Earnings, and Firm Reporting Discretion , 2000 .

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

[25]  Paul Zarowin,et al.  The boundaries of financial reporting and how to extend them , 1999 .

[26]  Thomas Z. Lys,et al.  Post‐Earnings Announcement Drift and the Dissemination of Predictable Information* , 1999 .

[27]  Brian J. Bushee,et al.  Fundamental Analysis Future Earnings, and Stock Prices , 1997 .

[28]  Richard R. Mendenhall.  Evidence on the Possible Underweighting of Earnings-Related Information , 1991 .

[29]  Madhav V. Rajan,et al.  The Revenue Implications of Financial and Operational Measures of Product Quality , 2001 .

[30]  E. Ziegel,et al.  Balanced Scorecard , 2019, Encyclopedia of Public Administration and Public Policy, Third Edition.

[31]  D. Shores,et al.  Firm Size, Security Returns, and Unexpected Earnings: The Anomalous Signed‐Size Effect* , 1993 .

[32]  D. Larcker,et al.  Innovations in Performance Measurement: Trends and Research Implications , 1998 .

[33]  B. Lev,et al.  Fundamental Information Analysis , 1993 .

[34]  F. Narin,et al.  Science and Technology as Predictors of Stock Performance , 1999 .

[35]  Suresh Kotha,et al.  Does the Quality of Online Customer Experience Create a Sustainable Competitive Advantage for E-Commerce Firms? , 2000 .

[36]  P. Elgers,et al.  Delayed Security Price Adjustments to Financial Analysts' Forecasts of Annual Earnings , 2001 .

[37]  Wayne S. Upton.  Business and financial reporting, challenges from the new economy , 2001 .

[38]  Richard A. Zuber,et al.  The Investment Performance of Common Stocks in Relation to Their Price-Earnings Ratios: An Update of the Basu Study , 1989 .

[39]  Bruce Kevin Behn.  Value implications of supplemental disclosures : the case of unfilled order backlogs , 1994 .

[40]  John A. Doukas,et al.  A Test of the Errors-in-Expectations Explanation of the Value/Glamour Stock Returns Performance: Evidence from Analysts' Forecasts , 2001 .

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

[42]  Robert H. Herz,et al.  The ValueReporting Revolution: Moving Beyond the Earnings Game , 2001 .

[43]  Aswath Damodaran,et al.  The Dark Side of Valuation: Valuing Old Tech, New Tech, and New Economy Companies , 2001 .

[44]  Beverly R. Walther,et al.  Investor Sophistication and Market Earnings Expectations , 1997 .

[45]  F. T. Magiera.  Do Stock Prices Fully Reflect Information in Accruals and Cash Flows about Future Earnings , 1997 .

[46]  Suresh Kotha,et al.  The Value-Relevance of Network Advantages: The Case of E-Commerce Firms , 2003 .

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

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

[49]  Andrei Shleifer,et al.  Good News for Value Stocks: Further Evidence on Market Efficiency , 1995 .

[50]  Josef Lakonishok,et al.  The Stock Market Valuation of Research and Development Expenditures , 1999 .

[51]  D. Larcker,et al.  Are nonfinancial measures leading indicators of financial performance? An analysis of customer satisfaction , 1998 .

[52]  April Klein,et al.  A direct test of the cognitive bias theory of share price reversals , 1990 .

[53]  Discussion of: “Do Stock Prices of Property Casualty Insurers Fully Reflect Information About Earnings, Accruals, Cash Flow and Development?” , 2001 .

[54]  James A. Ohlson,et al.  Book Rate-Of-Return And Prediction Of Earnings Changes - An Empirical-Investigation , 1982 .

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

[56]  B. Lev.  Intangibles: Management, Measurement, and Reporting , 2001 .

[57]  Kewei Hou,et al.  Market Frictions, Price Delay, and the Cross-Section of Expected Returns , 2003 .

[58]  B. Lev,et al.  Value-Relevance of Nonfinancial Information: The Wireless Communications Industry , 1996 .

[59]  Jeffery Abarbanell.  Do analysts' earnings forecasts incorporate information in prior stock price changes? , 1991 .

[60]  Suresh Kotha,et al.  Managerial Actions, Stock Returns, and Earnings: The Case of Business-to-Business Internet Firms , 2000 .

[61]  Douglas J. Skinner,et al.  Recommendations on Disclosure of Nonfinancial Performance Measures , 2002 .

[62]  S. Penman,et al.  FINANCIAL STATEMENT ANALYSIS AND THE PREDICTION OF STOCK RETURNS , 1989 .

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

[64]  Victor L. Bernard,et al.  Tests of Analysts' Overreaction/Underreaction to Earnings Information as an Explanation for Anomalous Stock Price Behavior , 1992 .

[65]  John E. Core,et al.  Market Valuations in the New Economy: An Investigation of What Has Changed , 2001 .

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

[67]  Mary E. Barth,et al.  Analyst Coverage and Intangible Assets , 2000 .