Over at Aswath Damodaran’s blog he recently put up thoughts on how to trade earnings announcements. Given that we have been spending most of the month waiting to see if any of our holdings or watchlist companies are releasing earnings and then vigorously updating our models, I thought that this would be an interesting read.
Differences across firms
There are studies that indicate that the returns associated with earnings surprises are more pronounced with some types of stocks than with others. For instance,
- A study of value and growth stocks found, instance, that the returns in the three days around earnings announcements were much more positive for value stocks (defined as low PE and PBV stocks) than for growth stocks across all earnings announcements – positive as well as negative. This suggests that you are much more likely to get a positive surprise with a value stock than with a growth stock, indicating perhaps that markets tend to be overly optimistic in their expectations for growth companies.
- Earnings announcements made by smaller firms seem to have a larger impact on stock prices on the announcement date and prices are more likely to drift after the announcement.
- As with analyst reports, there seems to be evidence that the market reaction to earnings reports is a function not only of the earnings number reported but also the accompanying management commentary.
- There is some evidence that the market reaction to earnings reports is greater at firms with high institutional ownership, with one rationale being offered that institutional investors tend to be more short term in their focus and thus more likely to respond to quarterly earnings reports.