Inflation, Earnings Forecasts, and Post-Earnings Announcement Drift

Abstract

We examine whether financial analysts fully incorporate expected inflation in their earnings forecasts for individual stocks. We find that expected inflation proxies, such as lagged inflation and inflation forecasts from the Michigan Survey of Consumers, predict the future earnings change of a portfolio long in high inflation exposure firms and short in low or negative inflation exposure firms, but analysts do not fully adjust for this relation. Analysts’ earnings forecast errors can be predicted using expected inflation proxies, and these systematic forecast errors are related to future stock returns. Overall, our evidence is consistent with the Chordia and Shivakumar (2005) hypothesis that the post-earnings announcement drift is related to investor underestimation of the impact of expected inflation on future earnings change.

Keywords: inflation illusion, analysts, earnings forecasts

JEL Classification: G14, G29, M41