Earnings vs. Stock Returns

August 10, 2012 8:30am by

MarketWatch – Good news: Earnings growth is slowing
Worried that lower earnings growth will lead to a bear market? You’re not alone. Almost everyone else is concerned too. But, by following the herd, you run the distinct possibility of becoming too worried: The stock market historically has performed better when earnings growth is slower than when it is faster. That at least is the conclusion reached by a study conducted by Ned Davis Research, the quantitative research firm. After analyzing year-over-year earnings growth back to 1927, the firm found that the stock market tends to underperform whenever earnings growth is particularly strong. The reason for this counterintuitive finding, according to Ed Clissold and Dan Sanborn, U.S. market strategists for Ned Davis Research and co-authors of the study: The market senses that high earnings growth is unsustainable, and is therefore discounting an imminent “slower earnings-growth environment.”

Comment

We conducted a similar study recently, measuring stock returns during the month following earnings season.  Whether starting the study in 1992, as the top chart highlights, or 2000, as the bottom chart illustrates, the percentage of companies beating earnings estimates has little-to-no effect on subsequent stock returns.  This is in line with our theory that earnings estimates are largely a gamed statistic.  We should not expect a manipulated number to have any sort of consistent relationship to stock returns.
Click to enlarge:

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Source: Bianco Research

 

 

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For more information on this institutional research, please contact:

Max Konzelman
max.konzelman@arborresearch.com
800-606-1872

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