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Earnings Acceleration and Stock Returns

Last Updated on 10 February, 2024 by Rejaul Karim

In this insightful exploration “Earnings Acceleration and Stock Returns” published in the Journal of Accounting & Economics, Shuoyuan He of San Francisco State University and Ganapathi S. Narayanamoorthy of Tulane University delve into the compelling realm of earnings acceleration and its impact on stock returns.

The research reveals a noteworthy finding: earnings acceleration, representing the quarter-over-quarter change in earnings growth, possesses significant explanatory power for future excess returns. What makes this discovery particularly robust is its resilience across a spectrum of previously identified anomalies and a comprehensive set of risk controls.

The observed excess returns, amounting to 1.8% in a month-long window, rival those derived from well-established anomalies such as book-to-market, post-earnings announcement drift, and gross profitability.

The predictability of future returns aligns with investors assuming a seasonal random walk model for quarterly earnings, potentially overlooking the predictable implications of earnings acceleration on earnings growth two and three quarters ahead.

The research concludes by highlighting the potential for enhancing the excess returns from the fundamental earnings acceleration trading strategy by almost 45% through a nuanced focus on specific patterns of earnings acceleration.

This study offers valuable insights into the link between earnings acceleration and stock returns, positioning it as a crucial factor in understanding market dynamics and refining active investing strategies.

Abstract Of Paper

We document that earnings acceleration, defined as the quarter-over-quarter change in earnings growth, has significant explanatory power for future excess returns. These excess returns are robust to a wide range of previously documented anomalies as well as a battery of risk controls. The magnitude of the excess returns (1.8% in a month-long window) is comparable to those from book-to-market, post-earnings announcement drift and gross profitability anomalies. The future return predictability appears to be consistent with investors assuming a seasonal random walk model for quarterly earnings and missing predictable implications of earnings acceleration for earnings growth two and three quarters hence. Finally, the excess returns from the basic earnings acceleration trading strategy can be enhanced further by nearly 45% by focusing on specific patterns of earnings acceleration.

Original paper – Download PDF

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Author

Shuoyuan He
San Francisco State University

Ganapathi S. Narayanamoorthy
Tulane University – Accounting & Taxation

Conclusion

In this study by Shuoyuan He and Ganapathi S. Narayanamoorthy, the focus is on the significant explanatory power of earnings acceleration, specifically the quarter-over-quarter change in earnings growth, in predicting future excess returns.

The research establishes the robustness of these returns against various anomalies and risk controls, with a notable 1.8% excess return in a month-long window. This predictive power aligns with investors assuming a seasonal random walk model for quarterly earnings, potentially missing the implications of earnings acceleration for subsequent quarters.

Additionally, the basic earnings acceleration trading strategy proves fruitful, showing potential for a 45% enhancement by focusing on specific patterns of earnings acceleration. Overall, the findings offer valuable insights for active investors seeking to capitalize on the predictive nature of earnings acceleration in the stock market.

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FAQ

– What is the key finding of the research on earnings acceleration and its impact on stock returns?

The research reveals that earnings acceleration, defined as the quarter-over-quarter change in earnings growth, has significant explanatory power for future excess returns in the stock market. The observed excess returns, amounting to 1.8% in a month-long window, are robust against various anomalies and risk controls.

– How do the excess returns from earnings acceleration compare to well-established anomalies in finance?

The excess returns from earnings acceleration, as highlighted in the study, are comparable to those derived from well-established anomalies such as book-to-market, post-earnings announcement drift, and gross profitability. This finding underscores the significance of earnings acceleration as a factor influencing stock returns.

– What potential enhancement does the study suggest for the earnings acceleration trading strategy, and how can investors benefit from it?

The research suggests that the excess returns from the basic earnings acceleration trading strategy can be enhanced by nearly 45% by focusing on specific patterns of earnings acceleration. This insight provides active investors with the opportunity to refine their strategies and potentially capitalize on the predictive nature of earnings acceleration for future stock returns.

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