Get the drift: the know-how in picking big winners, ...

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Title Get the drift: the know-how in picking big winners, especially small-cap stocks, can be had by using revisions in security analysts' forecasts of company earnings
Author(s) Sean M. Hennessey
Date 1995
Volume 8
Issue 4
Start page 23
Abstract The mean monthly excess returns and pre- and postrevision period cumulative excess returns over the whole sample period (CARs) and for each year were then calculated for the two revision portfolios (Table 2, next page). In the months leading to a forecast revision, the results are as expected, given an efficient market. For both revision portfolios in the pre-revision months, excess return were large and moved in the same direction as the revision. This large return reaction runs through the total sample and for each of the years. Clearly, the market anticipates the release of new earnings-based information. Also, as expected, the return reaction isn't as strong for securities in the negative revision portfolio than those in positive revision portfolio. For positive revisions, the drift peaks in 1988 and 1989 with a cumulative excess return of about 2.5%, or 10% annually, for the one-month to three-month period following the month of the revision. For the negative portfolio, while more of the post-revision cumulative excess returns are significant, they are generally smaller. That means that a strategy of buying positive revision securities and short-selling negative revision securities would have generated excess returns in the first three post-revision months of between 2% and 4.3% in all years except 1984.(f.8) Apart from 1986, the small firms display much larger pre-and post-revision cumulative excess returns. Therefore, level of information may account for the drift in returns following revisions--the market is slow to react and impound all the information implicit in large earnings forecast revisions for small companies. This is the case even in years when the cumulative excess return in the pre-revision period is more than 10%. Again, this finding can't be simply a result of the small firm effect, but seems to be a function of the market's delayed reaction to revisions. For large firms, only one cumulative excess return in the pre-revision period is very large, an unexpected result since the richer information environment for large firms implies investors should have anticipated the large positive revisions.

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