Market Reaction to Patterns of Earnings

Abstract

Prior research shows that easily discernable patterns in earnings -- strings of earnings increases (decreases) and breaks in such strings -- affect investors’ long-term valuation of stocks. We examine short-term market reaction before, during, and after earnings announcements to formally test how investors process news of continuation or the end of strings relatively to non-patterned firms. Our results confirm differential reaction measured with cumulative abnormal returns (CARs) between patterned and non-patterned firms. However, we observe the strongest market response to announcements of breaks, than to strings or non-patterned firms. Post-announcement drift (PEAD) and pre-announcement “leakage” is mostly attributable to break firms as well. Our results hold after controlling for information released in earnings announcements and characteristics of firms, patterns and information environment. Breaks in earnings strings might be one of the driving forces behind previously documented market anomalies surrounding earnings announcements, as investors need to re-valuate the stocks when earnings patterns end.