Does the Stock Market Fully Appreciate the Implications of Leading Indicators for Future Earnings? Evidence from Order Backlog

Abstract

A number of recent studies assume market efficiency and hence interpret an association between stock returns and leading indicators as evidence of the contribution of such indicators to future earnings. We explicitly examine (i) whether one leading indicator - order backlog - has predictive ability for future earnings, and (ii) whether market participants correctly incorporate such predictive ability in determining share prices. We find that the stock market overweights the contribution of order backlog in predicting future earnings and a hedge strategy that takes positions on the cross-sectional distribution of backlog generates significant future abnormal returns. Additional analysis indicates that the market mispricing is not due to analysts' inability to incorporate order backlog into their earnings forecasts.

JEL Classification: G12, G14, G29, M41