Analystss Earnings Surprise Components and Future Earnings Performance

Abstract

Our paper examines the association between components of analysts’ earnings surprises and future earnings. We decompose the analysts’ earnings surprise into its revenue, pretax margin, pretax income, and tax components. After controlling for current period earnings and discretionary accruals, we find that each component is positively associated with future earnings. When we form portfolios based on the sign of the earnings surprise and its components, we find that the future earnings of firms that meet revenue, pretax income, and net income expectations is significantly greater than firms that only meet net income expectations. Supplemental analysis shows that the significant association between future earnings and the revenue and pretax income components of the earnings surprise persists for at least three years. However, the association between the tax surprise and future earnings dissipates after one year. Overall, our evidence shows that decomposing earnings surprises into its components can assist investors in identifying firms that are associated with better future performance.