The Reversal of Abnormal Accruals and the Market Valuation of Earnings Surprises

2001 ◽  
Vol 76 (3) ◽  
pp. 375-404 ◽  
Author(s):  
Mark L. DeFond ◽  
Chul W. Park
Keyword(s):  
Stock Returns ◽  
Earnings Forecasts ◽  
Market Valuation ◽  
Working Capital ◽  
Future Earnings ◽  
Market Participants ◽  
Announcement Date ◽  
Earnings Surprises ◽  
Abnormal Accruals ◽  
The Difference

If the market anticipates the reversing nature of abnormal working capital accruals, then the reported magnitude of earnings surprises that contain abnormal accruals will differ from the underlying magnitude that is priced by the market. We expect the market's perception of this difference to affect the ERCs associated with earnings surprises that contain abnormal accruals. We test our predictions using an abnormal accruals measure that captures the difference between reported working capital and a proxy for the market's expectations of the level of working capital required to support current sales levels. Consistent with our hypotheses, we find higher ERCs when abnormal accruals suppress the magnitude of earnings surprises, and lower ERCs when abnormal accruals exaggerate the magnitude of earnings surprises. We also find results consistent with analysts predictably considering the reversing implications of abnormal accruals in revising future earnings forecasts. These findings are consistent with market participants anticipating the reversing implications of abnormal accruals. However, analysis of subsequent stock returns provides evidence that market participants do not fully impound the pricing implications of abnormal accruals at the earnings announcement date.

Discussion—Innovation, Future Earnings, and Market Efficiency

2005 ◽  
Vol 20 (4) ◽  
pp. 419-422 ◽  
Author(s):  
Chandra Seethamraju
Keyword(s):  
Stock Returns ◽  
Stock Prices ◽  
Citation Impact ◽  
Earnings Forecasts ◽  
Patent Citation ◽  
Time Lags ◽  
Future Earnings ◽  
Market Participants ◽  
Technological Advances ◽  
Abnormal Stock Returns

This study considers patent citation impact as a proxy for a leading indicator of technology firms' innovation capabilities. The author examines whether patent citation impact is associated with future earnings and whether this association is appropriately reflected in stock prices and analysts' earnings forecasts of patent-rich companies. The author reports results which indicate that change of patent citation impact is positively associated with future earnings up to five years in the future, particularly in the computer, electronics, and medical equipment industries. These are industries with relatively short time lags between technological advances and profit realization. The author also reports that investors and analysts do not seem to fully incorporate the implication of enhanced innovation capabilities for future earnings into stock prices and earnings forecasts. Based on this information, the paper develops a trading strategy that generates future abnormal stock returns. In my view, this paper asks an important question. If a researcher could come up with an appropriate leading measure of innovation, then examining the reliability of that measure through its association with future benefits, and whether the implications of the measure are understood by market participants, is an interesting exercise. In my discussion, I will focus on (a) some of the issues with the patent citation index (the measure of innovation capabilities), (b) problems with the databases used to construct this measure which suggest that the results should be interpreted with caution, and (c) some additional comments on the mispricing and portfolio tests.

scholarly journals The Role of Anchoring Bias in the Equity Market: Evidence from Analysts’ Earnings Forecasts and Stock Returns

2012 ◽  
Vol 48 (1) ◽  
pp. 47-76 ◽  
Author(s):  
Ling Cen ◽  
Gilles Hilary ◽  
K. C. John Wei
Keyword(s):  
Stock Returns ◽  
Earnings Forecasts ◽  
Equity Market ◽  
Stock Splits ◽  
Forecast Errors ◽  
Forecast Revisions ◽  
Earnings Per Share ◽  
Earnings Surprises ◽  
Anchoring Bias

AbstractWe test the implications of anchoring bias associated with forecast earnings per share (FEPS) for forecast errors, earnings surprises, stock returns, and stock splits. We find that analysts make optimistic (pessimistic) forecasts when a firm’s FEPS is lower (higher) than the industry median. Further, firms with FEPS greater (lower) than the industry median experience abnormally high (low) future stock returns, particularly around subsequent earnings announcement dates. These firms are also more likely to engage in stock splits. Finally, split firms experience more positive forecast revisions, more negative forecast errors, and more negative earnings surprises after stock splits.

Earnings Surprises that Motivate Analysts to Reduce Average Forecast Error

2008 ◽  
Vol 83 (2) ◽  
pp. 303-325 ◽  
Author(s):  
Orie E. Barron ◽  
Donal Byard ◽  
Yong Yu
Keyword(s):  
Private Information ◽  
Forecast Error ◽  
Earnings Forecasts ◽  
Forecast Errors ◽  
Future Earnings ◽  
Earnings Surprises ◽  
The Mean ◽  
Negative Earnings

Large earnings surprises and negative earnings surprises represent more egregious errors in analysts' earnings forecasts. We find evidence consistent with our expectation that egregious forecast errors motivate analysts to work harder to develop or acquire relatively more private information in an effort to avoid future forecasting failures. Specifically, we find that after large or negative earnings surprises there is a greater reduction in the error in individual analysts' forecasts of future earnings, and these individual forecasts are based more heavily on individual analysts' private information. This increased reliance on private information reduces the error in the mean forecast of upcoming earnings (even after controlling for the effect of reduced error in individual forecasts). As reliance on private information increases, more of each individual forecast error is idiosyncratic, and thus averaged out in the computation of the mean forecast.

Extracting Forward-Looking Information from Security Prices: A New Approach

2008 ◽  
Vol 83 (4) ◽  
pp. 1101-1124 ◽  
Author(s):  
Dan Weiss ◽  
Prasad A. Naik ◽  
Chih-Ling Tsai
Keyword(s):  
Time Series ◽  
Stock Returns ◽  
Time Series Models ◽  
Security Prices ◽  
Firm Level ◽  
Analyst Following ◽  
New Approach ◽  
Future Earnings ◽  
Market Participants ◽  
Forward Looking

ABSTRACT: This paper proposes a new index to extract forward-looking information from security prices and infer market participants’ expectations of future earnings. The index, called market-adapted earnings (MAE), utilizes stock returns and fundamental accounting signals to estimate market expectations of future earnings at the firm level. MAE outperforms time-series models (e.g., random-walk) in predicting future earnings. Results demonstrate the usefulness of MAE for firms that have no analyst following.

Management Forecasts in Japan: An Empirical Study of Forecasts that Are Effectively Mandated

2009 ◽  
Vol 84 (5) ◽  
pp. 1575-1606 ◽  
Author(s):  
Kazuo Kato ◽  
Douglas J. Skinner ◽  
Michio Kunimura
Keyword(s):  
Forecast Accuracy ◽  
Earnings Forecasts ◽  
Fiscal Year ◽  
Management Forecasts ◽  
Insider Ownership ◽  
Market Participants ◽  
Earnings Surprises ◽  
History Of ◽  
Study Management ◽  
Reputation Effects

ABSTRACT: We study management forecasts in Japan, where forecasts are effectively mandated but managers have considerable latitude over the numbers they release. We find that managers' initial earnings forecasts for a fiscal year are systematically upward-biased but that they revise their forecasts downward during the fiscal year so that most earnings surprises are non-negative. Managers' initial forecast optimism is inversely related to firm performance, and is more pronounced for firms with higher levels of insider ownership, smaller firms, and firms with a history of forecast optimism. The fact that managers' forecasts tend to be consistently optimistic suggests that reputation effects are insufficient to ensure managerial forecast accuracy. We also find that the information content of managers' forecasts is related to proxies for whether market participants view the forecasts as credible.

Do Investors Fully Unravel Persistent Pessimism in Analysts' Earnings Forecasts?

2017 ◽  
Vol 93 (3) ◽  
pp. 349-377 ◽  
Author(s):  
David Veenman ◽  
Patrick Verwijmeren
Keyword(s):  
Stock Returns ◽  
Earnings Forecasts ◽  
Analyst Forecast ◽  
Short Term ◽  
Market Prices ◽  
Earnings Expectations ◽  
Earnings Surprises ◽  
Announcement Returns ◽  
Low Probability ◽  
Jel Classifications

ABSTRACT This study presents evidence suggesting that investors do not fully unravel predictable pessimism in sell-side analysts' earnings forecasts. We show that measures of prior consensus and individual analyst forecast pessimism are predictive of both the sign of firms' earnings surprises and the stock returns around earnings announcements. That is, we find that firms with a relatively high probability of forecast pessimism experience significantly higher announcement returns than those with a low probability. Importantly, we show that these findings are driven by predictable pessimism in analysts' short-term forecasts, as opposed to optimism in their longer-term forecasts. We further find that this mispricing is related to the difficulty investors have in identifying differences in expected forecast pessimism. Overall, we conclude that market prices do not fully reflect the conditional probability that a firm meets or beats earnings expectations as a result of analysts' pessimistically biased short-term forecasts. JEL Classifications: G12; G14; G20.

The Information Content of Quarterly Dividend Changes

1995 ◽  
Vol 10 (2) ◽  
pp. 293-317 ◽  
Author(s):  
Thomas J. Carroll
Keyword(s):  
Stock Returns ◽  
Earnings Forecasts ◽  
Positive Association ◽  
Earnings Forecast ◽  
Forecast Errors ◽  
Cross Sectional ◽  
Future Earnings ◽  
New Information ◽  
Dividend Announcements ◽  
Dividend Increases

This paper shows that dividend changes reveal new information about future earnings levels and are mixed with regard to future earnings variance. Revisions of Value Line earnings forecasts spanning up to five quarters have a positive association with unexpected dividend changes. Consistent with the negative association documented between dividend changes and future earnings variance, these revisions also exhibit greater cross-sectional dispersion following dividend decreases than following dividend increases. The relation between stock returns and earnings forecast errors following dividend announcements shows that dividend announcements convey information to the market about earnings in the next quarter and the quarter one year hence, but are not consistent with dividends revealing new information about the variance of future earnings.

scholarly journals Innovation, Future Earnings, and Market Efficiency

2005 ◽  
Vol 20 (4) ◽  
pp. 385-418 ◽  
Author(s):  
Feng Gu
Keyword(s):  
Stock Returns ◽  
Stock Prices ◽  
Citation Impact ◽  
Earnings Forecasts ◽  
Patent Citation ◽  
Future Market ◽  
Time Lags ◽  
Future Earnings ◽  
Technological Advances ◽  
Abnormal Stock Returns

This study examines whether patent citation impact, a leading indicator of technology firms' innovation capabilities, is associated with future earnings and whether this association is appropriately reflected in stock prices and analysts' earnings forecasts of patent-rich companies. The results indicate that change of patent citation impact is positively associated with future earnings, particularly in industries with relatively short time lags between technological advances and profit realization (e.g., computers, electronics, and medical equipment). The strength of this relation also significantly increases with time for up to five years in the future. Market participants, including investors and analysts, however, do not fully incorporate the implication of enhanced innovation capabilities for future earnings into stock prices and earnings forecasts. This bias is significantly associated with future abnormal stock returns.

scholarly journals Idiosyncratic risk and the cross-section of stock returns: the role of mean-reverting idiosyncratic volatility

2018 ◽  
Vol 294 (1-2) ◽  
pp. 419-452 ◽  
Author(s):  
Stanislav Bozhkov ◽  
Habin Lee ◽  
Uthayasankar Sivarajah ◽  
Stella Despoudi ◽  
Monomita Nandy
Keyword(s):  
Stock Returns ◽  
Risk Premium ◽  
Empirical Studies ◽  
Idiosyncratic Risk ◽  
Risk Tolerance ◽  
Idiosyncratic Volatility ◽  
Market Participants ◽  
The Mean ◽  
The Difference ◽  
Risk Metric

Abstract A key prediction of the Capital Asset Pricing Model (CAPM) is that idiosyncratic risk is not priced by investors because in the absence of frictions it can be fully diversified away. In the presence of constraints on diversification, refinements of the CAPM conclude that the part of idiosyncratic risk that is not diversified should be priced. Recent empirical studies yielded mixed evidence with some studies finding positive correlation between idiosyncratic risk and stock returns, while other studies reported none or even negative correlation. We examine whether idiosyncratic risk is priced by the stock market and what are the probable causes for the mixed evidence produced by other studies, using monthly data for the US market covering the period from 1980 until 2013. We find that one-period volatility forecasts are not significantly correlated with stock returns. The mean-reverting unconditional volatility, however, is a robust predictor of returns. Consistent with economic theory, the size of the premium depends on the degree of ‘knowledge’ of the security among market participants. In particular, the premium for Nasdaq-traded stocks is higher than that for NYSE and Amex stocks. We also find stronger correlation between idiosyncratic risk and returns during recessions, which may suggest interaction of risk premium with decreased risk tolerance or other investment considerations like flight to safety or liquidity requirements. We identify the difference between the correlations of the idiosyncratic volatility estimators used by other studies and the true risk metric the mean-reverting volatility as the likely cause for the mixed evidence produced by other studies. Our results are robust with respect to liquidity, momentum, return reversals, unadjusted price, liquidity, credit quality, omitted factors, and hold at daily frequency.

Corporate Disclosure, Analyst Forecast Dispersion, and Stock Returns

2016 ◽  
Vol 34 (1) ◽  
pp. 54-73 ◽  
Author(s):  
Ashiq Ali ◽  
Mark Liu ◽  
Danielle Xu ◽  
Tong Yao
Keyword(s):  
Stock Returns ◽  
Earnings Forecasts ◽  
Bad News ◽  
Analyst Forecast ◽  
Corporate Disclosure ◽  
Forecast Dispersion ◽  
Negative Relation ◽  
Future Earnings ◽  
Disclosure Practice ◽  
Analyst Forecast Dispersion

This article examines whether a corporate disclosure practice is one of the reasons for the forecast dispersion anomaly—the negative relation between analyst forecast dispersion and future stock returns. Prior studies have shown that firms tend to delay the disclosure of bad news and that withholding of news leads to greater dispersion in analysts’ forecasts. Accordingly, we predict that firms with higher dispersion in analysts’ earnings forecasts are more likely to experience poor earnings in the subsequent quarter, and find evidence consistent with this prediction. After controlling for the relation between forecast dispersion and future earnings, we find that forecast dispersion is no longer significantly negatively related to future stock returns. These results suggest that temporary withholding of bad news by firms increases forecast dispersion among analysts and leads to low subsequent stock returns.

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