Changes in Order Backlog and Future Returns

Abstract

This paper examines whether investors recognize the implications of changes in order backlog, a non-GAAP leading indicator, for future performance. A hedge portfolio strategy taking a long position in the highest decile of order backlog change and a short position in the lowest decile of order backlog change earns 13.7 percent in the year after the hedge portfolio is formed. Moreover, analysts’ forecast errors are large and negative (overoptimistic) for firms experiencing declines in order backlog. Overall, our evidence indicates that analysts underreact to the information in changes in order backlog. In addition, the market does not appear to see through the relation between changes in order backlog and future performance and underweights the implications of order backlog, which contrasts with the findings of Rajgopal, Shevlin, and Seoul Journal of Business Volume 13, Number 2 (December 2007) * Main author, Assistant Professor of Accounting, Graduate School of Business, Seoul National University (bbaik@snu.ac.kr). ** Coauthor, Professor of Accounting, Graduate School of Business, Seoul National University (ahnts@snu.ac.kr). We appreciate the helpful comments from two anonymous reviewers. We also thank IBES, a service of Thomson Financial, for providing data as part of a broad academic program to encourage earnings expectation research. The authors acknowledge financial support from the Institute of Management Research, Seoul National University. Venkatachalam (2003).