Common Stock Returns Surrounding Earnings Forecast Revisions: More Puzzling Evidence.

Abstract The relation between changing expectations of earnings and changing security prices is a central issue in accounting and finance. In this article, I reexamine common stock returns surrounding earnings forecast revisions, using a large database of individual analyst forecasts, and provide new evidence on market expectations of revisions, on cross-sectional differences in price effects, and on the influence of confounding events. In summary, my findings are that revisions affect prices, but prices do not immediately assimilate the information Price reaction is greater when the percentage change in forecast is in the top or bottom five percent of the distribution of all forecast revisions. This price effect is not simply due to an association between revisions and earnings, dividend, or stock-split announcements Surprisingly, prices continue to drift in the direction of the revision for about six months after the revision. Another surprise is that price reaction does not incorporate some publicly available information. Stock returns immediately after individual analyst forecast revisions suggest that an analyst's current outstanding forecast is a better measure of the market expectations of the analyst's next forecast than an updated version (i.e., the analyst's current forecast updated for information revealed after the date of the current forecast but before the date of the next forecast). I use this curious price reaction result to create an aggressive trading strategy that predicts changes in outstanding forecasts, in other words, a strategy that predicts price reactions. The difference in abnormal returns between securities predicted to perform best and worst is more than 13 percent every six months. Changes in beta do not explain these abnormal returns.