Return Predictability and Trends
We report that trends defined by the sign of quarterly earnings surprises predict returns. This finding indicates that trends in firm-level fundamentals bias investor expectations. Specifically, the underreaction of investors to trends is consistent with the gambler’s fallacy in Rabin (2002). The return predictability of trends is not attributable to the magnitude of earnings surprises. Instead, trends explain more than half of the post-earnings announcement drift in our sample.