Pocket PhD: Post Earning Announcment Drift (PEAD)

Each quarter when companies report their earnings, there are usually a handful of companies whose earnings are either surprisingly good, or shockingly bad. You can immediately recognize these companies by the post earnings announcement jump or plunge in their respective stock prices. So far so good. But now fast forward, say, three quarters. If you take a look at all the stocks that had negative earnings surprises, you find that on average these stocks continued to go down. Similarly, the stocks that had positive earnings surprises continued to go up, on average. In other words, the stocks with earnings surprises exhibit post earnings announcement drift, or PEAD for short. Now this is weird. Every finance professor will tell you that this isn't suppose to happen. If the stock market is efficient, what should happen is a one-time jump in the stock price when earnings are announced.

This PEAD effect was first identified in a paper published in 1968, almost 40 years ago. Generally, when research on market inefficiencies is published, people start trading against the inefficiency and the anomoly goes away. But not with PEAD. Subsequent papers have overwhelmingly found the same result. PEAD is considered one of the most robust stock market anomalies around. And, so far, nobody really knows why....

We'll look into some possible explanations in future installments of the Pocket PhD Project. For some papers on the subject, see here and here. For more about P3, see here.