Expectations and Share Prices

Abstract

It is generally believed that security prices are determined by expectations concerning firm and economic variables. Despite this belief there is very little research examining expectational data. In this paper we examine how expectations concerning earning per share effect share price. We first show that knowledge concerning analyst's forecasts of earnings per share cannot by itself lead to excess returns. Any information contained in the consensus estimate of earnings per share is already included in share price. Investors or managers who buy high growth stocks where high growth is determined by consensus beliefs should not earn an excess return. This is not due to earnings having no effect upon share price since knowledge of actual earnings leads to excess return. Much larger excess returns are earned if one is able to determine those stocks for which analysts most underestimate return. Finally, the largest returns can be earned by knowing which stocks for which analysts will make the greatest revision in their estimates. This pattern of results suggests that share price is affected by expectations about earnings per share. Given any degree of forecasting ability managers can obtain best results by acting on the differences between their forecasts and concensus forecasts.