Earnings Quality and the Pricing Effects of Earnings Patterns

Abstract:     
We examine whether pricing effects associated with three earnings patterns (increasing annual earnings, quarterly earnings that consistently meet or exceed analyst forecasts, and smooth earnings) are related to each other and, separately, to the quality of the underlying earnings. We identify distinctly-priced incremental elements of increasing earnings and earnings quality. While the statistical significance of the incremental pricing effects of earnings smoothness and of patterns of earnings that meet or exceed analyst forecasts are mixed, in all cases, their economic importance is modest. Our main finding concerns the relation between the pricing effects of earnings patterns and earnings quality: holding constant the level of the pattern, the largest (smallest) pricing effects are associated with earnings patterns supported by high (low) quality earnings. Moreover, for all three earnings patterns, we document that the market either attaches no reward to, or imposes a penalty on, patterns achieved with low quality earnings.

Number of Pages in PDF File: 53

Keywords: earnings patterns, earnings quality

JEL Classification: G12, M41, M43, G29

working papers series