Does Stock Market Appreciate the Implication of Order Backlog for Future Earnings? A Re-examination

Abstract

The main purpose of this paper is to study whether the level of order backlog is comparable across firms and whether realized current earnings should contain information in the level of order backlog in the previous year or not. We first demonstrate that the mean of the level of order backlog varies widely across firms. Then, we present transition matrices to show that firms have a strong tendency to remain in the neighborhood of the deciles, based on the level of order backlog, in the previous year. Therefore, it is hard to argue that a hedge portfolio based on the decile ranking of the level of order backlog could earn persistent abnormal returns. We further argue that in a cross sectional model and given current earnings, a better measurement of the order backlog information to test whether this leading indicator predicts future earnings is the change in order backlog, not the level of it. This issue is important since the evidence of market inefficiency could be due to the uncontrolled industry factor or other firm characteristics. In addition, the results that analysts seem to fully appreciate the implication of order backlog for future earnings could be due to the measurement error of the explanatory variable.Our results show that change in order backlog, not the level of order backlog, has incremental information about future earnings over current earnings. In addition, financial analysts are not able to adequately appreciate the implication of order backlog information about future earnings.