Consistency of firms' past financial performance measures and future returns

Abstract

In this study, I show that growth consistency in firms' past financial performance measures is useful in predicting future stock returns. Firms consistently ranking in the lowest 30 percent of past financial growth measures have greater rates of returns relative to their inconsistent low-growth firm counterparts. The return differential between these two groups increases uniformly with the length of estimation intervals of past performance data. Firms consistently ranking in the top 30 percent of growth rates earn slightly lower returns than inconsistent high-growth firms. These findings indicate that investors overreact to consistency in financial metrics, but this overreaction is more pronounced and persistent for consistent low-growth firms than that for consistent high-performing firms. Regression analyses reveal that consistency of firms' past financial performance predicts subsequent price movement. This association between past growth consistency and future returns is stronger for consistent low-growth firms relative to consistent high-growth firms.