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Earnings announcement period is an essential time for many equity traders. It is time when most of the stocks move with higher volatility, which offers the more significant potential for profit. We present an interesting research paper that helps to increase the odds of correctly pick outperforming (and underperforming) stocks during this period. The article shows that the timing of stock repurchase announcement and secondary equity offering (SEO) announcement is an important predictor of performance during earnings announcement. Managers have the ability to time stock repurchase and SEO announcements. Academic research shows managers choose to buyback stocks when they expect good earnings announcement, and they prefer to execute SEO before bad earnings. Therefore investors could look for these indicators and build long-only (with the help of information from stock repurchase announcements) of long-short (short leg with help from SEO announcement date) trading portfolio with attractive characteristics. We insert the long-only description into our database (as it is easier to build and trade). Still, we recommend also reviewing the long-short version of this strategy described in the source academic paper.
Fundamental reason
The academic paper states that it is generally accepted that managers have more information about the firm than investors. Given this information asymmetry, managers can make informed decisions about corporate actions such as equity offerings or repurchases. The announcement of stock repurchase or secondary equity offering is voluntary and can be easily moved by a few weeks or months. Therefore the timing of SEO or repurchase announcement before earnings announcement could be perceived as important information about the future performance of stock during the earnings announcement period.
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Keywords
Strategy profile
- Market factors
- Equities
- Financial instruments
- Stocks
- Regions
- United States
- Number of traded instruments
- 100
average number of stocks held during one earning announcement period
- Complexity
- Moderate
- Rebalancing period
- Daily
- Confidence in anomaly's validity
- Strong
- Transaction costs
- Mentioned
Transaction/trading costs are not deducted from reported returns. Section 5.1 notes that small firms may be illiquid and have higher trading costs; bid-ask spreads are also used as an information-asymmetry proxy in Section 6. No numerical trading-cost, commission, spread, or slippage assumption is applied to the primary backtest.
- Robustness checks
- Assessed
Section 5/Table 4 re-runs the primary earnings-announcement return analysis excluding firms below $100m market cap, excluding financial/utilities, and excluding small actions (buybacks <5% or SEOs <10% of shares); the buyback-minus-SEO return differential remains economically and statistically significant. Table 5 splits the sample into 1994–2000, 2001–05, 2006–10, and 2011–15; predictability persists, though later-period results are weaker. The authors also state that using wider corporate-action/earnings gaps and alternative factor models/estimation periods gives consistent results (Section 3.1 and footnote 4).
Source-paper performance
- Backtest period
- 1987 – 2013
- Indicative performance
- 25.2%
per annum, annualized return (geometrically, four earnings announcement periods per year, average return 5,78% per announcement), data from table 7C for period (-10,+15) for analysis excluding small firms
- Estimated volatility
- 11.11%
estimated from t-statistic 10.81, data from table 7C for period (-10,+15) for analysis excluding small firms
- Maximum drawdown
- Not reported
not stated
- Sharpe ratio
- 2.27
Simple trading strategy
The investment universe consists of stocks from NYSE/AMEX/Nasdaq (no ADRs, CEFs or REITs), bottom 25% of firms by market cap are dropped. Each quarter, the investor looks for companies that announce a stock repurchase program (with announced buyback for at least 5% of outstanding stocks) during days -30 to -15 before the earnings announcement date for each company. Investor goes long stocks with announced buybacks during days -10 to +15 around an earnings announcement. The portfolio is equally weighted and rebalanced daily.
Hedge for stocks during bear markets
No – The selected strategy is designed as a long-only; therefore, it can't be used as a hedge against market drops as a lot of strategy's performance comes from equity market premium (as the investor holds equities, therefore, his correlation to the broad equity market is very very high).
Out-of-sample strategy implementation in QuantConnect (chart, statistics & code)
Source paper
Amini, Singal: Are Earnings Predictable?
Abstract: If managers use their superior information to time a firm’s corporate actions, it is likely that equity issuance will precede bad earnings while stock repurchase announcements will precede good earnings. Consistent with this conjecture, we find evidence of market timing and earnings predictability. The market reaction to earnings following repurchase announcements is statistically and economically significantly higher by 4.56% than earnings following SEO pricings over a 25 trading day window (-10, 15).