It’s generally believed firms who regularly meet or just beat earnings forecasts must be manipulating earnings to achieve this. Which makes sense, right; but is it true?
Guqiang Luo (et al.) from the Australian National University took a close look at 1,821 Chinese firms reporting between 2004 and 2019 to see if there were reliable patterns between how firms reported, the treatment of their stocks by investors subsequently and the reality of that manipulation charge.
First the findings:
- Yes, the stocks of firms that beat by a big margin forecast earnings do very well subsequently. Free money there then for anyone who can reliably predict such an outcome. Good luck with that!
- No, firms that meet or beat expectations slightly are not subsequently discovered to be manipulators. The market reaction though to this outcome suggests investors often believe them guilty of the practice.
The actionable advice then from this for investors is if you’re waiting to make a move on a stock because their next reporting is close, and the the company meet or beat-small the forecast, if the stock price then drops that’s a genuine opportunity.
Or, if you already have a position and there’s a pull back due to an earnings-meet or small-beat that’d be an opportunity for smart ingress.
One important caveat. The researchers point out that their work is China specific and, as that market is run more by the animal spirits of smaller investors than the steadier hands of the institutional types, the findings may not be applicable elsewhere (but I’d bet they are).
You can access the work in full via the following link Meet or Beat?
Happy Sunday.