Pre-Earnings Announcement Drift

Abstract

We present evidence of a predictable drift in stock prices before the earnings announcements of firms that announce their earnings later than other firms in their industry. We form portfolios based on the returns of later announcers that are implied by the abnormal returns of earlier announcers and the historical pair-wise covariance of the abnormal earnings announcement date returns of earlier and later announcers. A long-short trading strategy based on these implied returns generates monthly returns of more than 100 basis points. The drift is neither due to the well-known momentum effect nor a manifestation of post-earnings announcement drift; it is evident both between the earlier announcers’ earnings announcement dates and the later announcers’ earnings announcement dates and at the later announcers’ earnings announcement dates. The continued under-reaction after later announcers’ earnings announcements is shown to be an under-reaction to the later announcers’ own earnings announcements (i.e., post-earnings announcement drift) rather than a continued under-reaction to the earnings news of earlier announcers (i.e., pre-earnings announcement drift). We show that transaction costs explain the predictability of later announcers’ returns.