Naive Investors, Earnings Announcements, and Stock Price Movements

Abstract

This paper addresses the issue of whether investors with “naïve” earnings expectations (i.e., earnings forecasts that are systematically less accurate than other publicly available predictions) have sufficient market power to affect common stock prices. The results clearly indicate that when security analysts predict quarterly earnings increases (decreases), from the same fiscal quarter of the prior year, that the abnormal return around the upcoming earnings announcement tends to be positive. When the data are formed into 50 portfolios, about 66% of the abnormal return variation around earnings announcements is explained by the predicted earnings change. This is surprising since the forecasts used are dated from one to thirteen weeks before the earnings announcement.