The Earnings Announcement Return Cycle

Abstract

Stocks earn significantly negative abnormal returns before earnings announcements and positive after them. This "earnings announcement return cycle" (EARC) is unrelated to the earnings announcement premium, and it is a feature of stocks widely covered by analysts. Analysts' forecasts follow the same pattern as returns: analysts' forecasts become more optimistic after an earnings announcement and more pessimistic as the next one draws near. We attribute one-half of the earnings announcement return cycle to this optimism cycle. The EARC may stem from mispricing: both the return and optimism patterns are stronger among high-uncertainty and difficult-to-arbitrage stocks, and the EARC strategy is more profitable on days when it would accommodate larger amounts of arbitrage capital.