Earnings persistence, fundamentals, and anticipation of breaking earnings strings

Abstract

Using a sample of firms with consecutive earnings growth for more than 20 quarters (earnings strings), I assess the relationship between earnings persistence and the extent to which investors are able to anticipate breaks of earnings strings. I find that firm‐specific earnings persistence exhibits a concave trend during earnings strings. Stock returns are significantly and positively associated with earnings persistence. Upon breaks of earnings strings, investors’ reactions are more negative for firms with higher earnings persistence—especially those with smaller institutional holdings and analyst coverage, and those with insider selling activities—before the break. Additional analyses show that variations in firms’ economic performance (fundamentals) explain the varying earnings persistence during earnings strings. Copyright © 2015 ASAC. Published by John Wiley & Sons, Ltd.

The economic-based earnings persistence of earnings momentum and its market implications

“…Although Barth et al (1999) and Yao (2017) seem closely related to our study, there are obvious differences. First, unlike Barth et al (1999), we directly examine the valuation role of fundamentals-driven earnings persistence in the setting of earnings momentum.…”

“…This study contributes to the literature on earnings momentum in several ways. First, it shows that earnings momentum is associated with economic-based earnings persistence, complementing evidence of Chen (2013) and Yao (2017). Second, earnings momentum reflects true performance driven by firm fundamentals, contradicting Myers et al (2007) who argue that earnings management causes earnings momentum.…”

“…Barth et al (1999) provide empirical evidence suggesting that valuation premiums are still present after controlling for earnings persistence and persistence in abnormal earnings. Yao (2017) finds that fundamentals-driven earnings persistence is able to predict the impending end of an increasing earnings trend. His results also suggest that fundamentals-related information can account for earnings persistence over the course of earnings momentum.…”

“…Different from Barth et al (1999) who do not investigate the role of firm primitives associated with earnings persistence, our results corroborate that momentum of earnings varies with business economics of firms. Yao (2017) estimates the relation of earnings persistence before breaks of earnings momentum with investors' responses and shows that markets react negatively and significantly to firms with earnings patterns up on the breaks of such patterns. However, he seems to ignore whether investors evaluate firm fundamentals embedded in earnings persistence when rewarding firms who maintain their earnings momentum.…”

“…However, he seems to ignore whether investors evaluate firm fundamentals embedded in earnings persistence when rewarding firms who maintain their earnings momentum. Complement to Yao (2017), we examine whether market rewards are exclusively investors' reactions to distinct fundamentals of firms.…”