CONTACT: Bill Kinney, 512-471-3632, [email protected]
Study Shows "Earnings Surprise" Often Does Not Result in Material Stock Price Changes
August 30, 1999, Austin, TX -- A recent comprehensive study of analysts' forecasts and earnings reports concluded that "earnings surprise" -- the difference between forecasted and actual earnings per share for a company -- is not a major factor in stock price fluctuations. "Concerns that earnings surprises of small amounts typically lead to disproportionate stock price reactions at annual earnings announcements are unwarranted," said Professor William Kinney, director of the Center for Business Measurement and Assurance Services at the University of Texas Business School, and one of the study's authors.
Kinney and his colleagues found that in the seven-day period surrounding announcement of a company's annual earnings, the effect of earnings surprise on stock returns varied greatly across companies throughout 1992-1997. Among companies with positive earning surprise (actual earnings exceeded analysts' forecasted amounts), 43 percent experienced negative returns. At the same time, 46 percent of companies reporting negative earnings surprise (actual earnings fell short of forecasts), experienced positive returns. The same relationships hold approximately whether earnings surprises were plus or minus $.01, $1.01, or $2.01 per share or other magnitudes.
"Earnings surprise explains only a small proportion of the overall variation in returns over the announcement period," said Kinney. Other explanatory factors include the disagreement or dispersion among analysts' forecasts. Dispersion among analysts and the average number of days between the last composite forecast and the actual earnings release declined between 1992 and 1997. Moreover, the proportion of companies whose earnings exactly met the analysts' composite forecast, and thus had zero earnings surprise, increased by 41 percent.
The study also investigated whether stock prices have become more sensitive to earnings surprise in recent years. "We found no statistically significant evidence that stock prices were increasingly responsive to earnings surprise," said Kinney. Additionally, the research concluded that stock price reactions to earnings surprise did not differ significantly between companies with a high price to earnings (P/E) ratio compared to those with low P/E ratios.
The study, entitled "The Materiality of Earnings Surprise," is based on an analysis of more than 22,000 annual earnings composite forecasts and actual reported earnings between January 1, 1992 and December 31, 1997 obtained from First Call Corporation, a global research firm that tracks stock information for institutional and individual investors. Kinney's co-authors were David Burgstahler, professor of accounting at the University of Washington Business School, and Roger Martin, assistant professor of accounting and information systems at Indiana University's Kelley School of Business.
A longstanding leader in accounting education, The University of Texas at Austin is home to the top-ranked graduate accounting program (including the MPA and the PPA programs) in the country, according to the Public Accounting Report, an industry newsletter. As director of UT's Center for Business Measurement and Assurance Services, William Kinney helps leading information-based businesses understand how technology is altering basic business processes such as managerial accounting, internal control, attestation, public financial reporting, and taxation.
The complete study is available at www.bus.utexas.edu/~accounting/bmas.
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