Blog - Investing Notes
May 7, 2008 - Returns of High-Momentum Stocks Around Earnings Announcements
Do the attention-grabbing past returns of high-flying stocks produce pre-earnings
announcement buying frenzies? In the April 2008 version of their paper entitled
"Limited Attention
and the Earnings Announcement Returns of Past Stock Market Winners", David
Aboody, Reuven Lehavy and Brett Trueman examine whether the limited time and
resources of small investors explains a striking return pattern around the earnings
releases of firms with extremely strong prior year price momentum. Using daily
stock return data and earnings release/forecast news from the beginning of 1971
through the third quarter of 2005 for a broad sample of companies, they conclude
that:
- Stocks in the top 1% of prior year returns generate an average market-adjusted
return of +1.58% (-1.86%) during the five trading days before (after) earnings
announcements, excluding trading frictions.
- Within this set of high-fliers, stocks with earnings announcements unambiguously
occurring outside of normal trading hours generate an average market-adjusted
return of +3.09% (-3.05%) during the five trading days before (after) earnings
announcements, including a significant close-to-open
average return of +0.93% immediately after announcements as part of the pre-announcement
return. In other words, going long these stocks five days before earnings
announcements, closing the long positions at the first open after announcements
and then shorting until the close five days later generates an average market-adjusted
ten-day return of over 6%, excluding trading frictions.
- Assuming that all buys are at the ask and sells are at the bid to account
for bid-ask spread reduces the above average abnormal returns to +0.94% (-0.85%)
before (after) earnings announcements for all stocks in the top 1% of positive
momentum and +1.66% (-1.34%) for the subset of these stocks with announcements
clearly occurring outside of normal trading hours.
- Fore comparison, the average five-day pre-announcement (post-announcement)
market-adjusted return for the entire sample of stocks is just +0.30% (-0.1%).
- Neither contemporaneous pre-release/post-release analyst earnings forecast
revisions nor negative earnings surprises explain the anomalous returns.
- There is evidence of a pre-announcement order imbalance for small and medium-sized
traders that disappears post-announcement, suggesting that trading decisions
of individual investors drive the anomaly.
The following chart, taken from the paper, shows the cumulative average
market-adjusted return for stocks in the top 1% of prior year raw returns from
19 days before earnings announcements (-19) to 20 days after earnings announcements
(+20) over the entire sample period. Day 0 is the earnings announcement day.
The mean daily market-adjusted return is:
- +0.11% from days -19 through -5;
- +0.35% from days -4 through 0
- -0.35% for days 1 through 5;
- -0.06% for days 6 through 13; and,
- +0.12% for days 14 through 20.
The 1.98% cumulative average market-adjusted return over the entire 40-day
period represents a momentum return of about 1% per month.
In summary, traders may be able to exploit an attention-driven anomaly for
very high momentum stocks by going long from five days before to the morning
after earnings announcement and short the next five days.
For related research, see Blog
Synthesis: Momentum Investing/Trading.
