Earnings Surprise

Publicly traded firms have earnings announcements in which they release their earnings for the quarter or year. The market expects a certain level of earnings to be announced. An __earnings surprise__ is the unexpected portion of a firm’s earnings announcement. Suppose that XXX Corp. is expected to announce earnings of USD 3.00 per share and instead announces earnings of USD 3.20 per share. What would you expect to happen to the stock price of XXX Corp.?

Well done! If the market is efficient and prices reflect all available information, then the stock price of XXX should increase after the announcement of the earnings surprise. This is because XXX had higher earnings than expected which is a positive surprise.

Incorrect. If the market is efficient and prices reflect all available information, then the stock price of XXX should increase after the announcement of the earnings surprise. This is because XXX had higher earnings than expected which is a positive surprise.

Researchers have found that the market generally reacts in the right direction. In other words, in cases like the XXX surprise, the market price does generally increase. However, the size of the increase is generally not large enough, which causes positive surprise firms to continue to have abnormally high returns, even after the announcement of the surprise. What does this mean for market efficiency?

Incorrect. In order for the market to be efficient, the stock price should immediately move to the intrinsic value and there should be no longer-term abnormal returns following the announcement.

Exactly! In order for the market to be efficient, the stock price should immediately move to the intrinsic value and there should be no longer-term abnormal returns following the announcement.

In summary: [[summary]]

The earnings surprise anomaly has received a lot of attention from researchers, yet it still appears as though traders may be able to earn abnormal profits by taking advantage of this mispricing.

Stock price will increase

Stock price will decrease

The market is efficient

The market is not efficient

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