Naïve Earnings Growth Extrapolation
65 Pages Posted: 4 Aug 2021 Last revised: 29 Dec 2023
Date Written: August 2, 2021
Abstract
Using the unique financial reporting format in China, where quarterly earnings are reported on a year-to-date basis, we test behavioral finance models featuring fundamental extrapolation. We show that stocks with the strongest past year-to-date earnings growth experience a significant price run-up during the five trading days before their earnings announcements and a significant return reversal afterward. The return pattern is more pronounced for smaller stocks with a larger retail clientele and less analyst coverage. Corroborating evidence from retail investor buying demand suggests that investors naïvely extrapolate the salient but less informative year-to-date earnings growth when forecasting the upcoming earnings.
Keywords: Extrapolation, Earnings Announcements, Speculative Trading, Financial Reporting
JEL Classification: G14, G40, G41
Suggested Citation: Suggested Citation