Return Predictability and Trends in Earnings Surprises
Abstract
We document that trends in firm-level quarterly earnings surprises predict returns. Trends require consistency between the sign of a firm’s most recent earnings surprise and its prior earnings surprises. The return predictability of trends is not induced by the relatively large earnings surprises that define post-earnings announcement drift. Instead, trends in prior earnings surprises explain more than half of post-earnings announcement drift’s risk-adjusted return. Our evidence indicates that investors underreact to trends and therefore provides partial support for Rabin (2002)’s theory that investor expectations are influenced by the law of small numbers.
This paper has been withdrawn.
