Naïve Earnings Growth Extrapolation

71 Pages Posted: 4 Aug 2021

See all articles by Chenyu Cui

Chenyu Cui

University of International Business and Economics (UIBE) - Business School

Frank Weikai Li

Singapore Management University - Lee Kong Chian School of Business

Xinyi Zhang

Sun Yat-Sen University (SYSU) - Business School

Date Written: August 2, 2021

Abstract

Exploiting the unique financial reporting format in China, we document that stocks with the strongest past year-to-date earnings growth experience a significant price run-up of 1.2% during the five trading days before their quarterly earnings announcements and a significant return reversal of -1.35% in the five trading days afterward. This inverted V-shaped pattern on cumulative return spreads is more pronounced among smaller firms with lower institutional ownership and fewer analyst coverage, and it is less pronounced among foreign B-share. Consistent with investor excess demand driving the price run-up, we find retail investor sentiment and buy-sell order imbalance rise ahead of earnings announcements for firms with high past earnings growth. Our findings support models of fundamental extrapolation and suggest investors naively extrapolate the salient but not-so-informative year-to-date earnings growth when forming expectations about the upcoming earnings.

Keywords: Extrapolation, Earnings Announcements, Speculative Trading, Financial Reporting

JEL Classification: G14, G40, G41

Suggested Citation

Cui, Chenyu and Li, Frank Weikai and Zhang, Xinyi, Naïve Earnings Growth Extrapolation (August 2, 2021). Available at SSRN: https://ssrn.com/abstract=3897761 or http://dx.doi.org/10.2139/ssrn.3897761

Chenyu Cui

University of International Business and Economics (UIBE) - Business School ( email )

Beijing
China

Frank Weikai Li

Singapore Management University - Lee Kong Chian School of Business ( email )

469 Bukit Timah Road
Singapore 912409
Singapore

Xinyi Zhang (Contact Author)

Sun Yat-Sen University (SYSU) - Business School ( email )

135 Xingang West Road
Sun Yat-Sen University
Guangzhou, Guangdong 510275
China

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