TAILIEUCHUNG - Earnings Surprises, Growth Expectations, and Stock Returns or Don’t Let an Earnings Torpedo Sink Your Portfolio∗

Liquidity is vitally important as it can contribute towards a higher or lower share price. In very simplistic terms, a hypothetical company in an attractive industry sector with a track record of delivering good results and with a well-diversified share register and reasonable levels of buying and selling in its shares, should maintain a consistentl fair share price – in part because it has a consiste approach to investor relations, spending time and effort courting institutional and private investor interest to the extent the latter will want to buy and/or hold the shares. Contrast this with an equally hypothetical compan that has an inconsistent. | Earnings Surprises Growth Expectations and Stock Returns or Don t Let an Earnings Torpedo Sink Your Portfolio Douglas J. Skinner and Richard G. Sloan University of Michigan Business School First Version May 1998 This Version January 2000 Abstract It is well established that the realized returns of growth stocks have been low relative to other stocks. We show that this phenomenon is explained by a large and asymmetric response to negative earnings surprises for growth stocks. After controlling for this effect there is no longer evidence of a stock return differential between growth stocks and other stocks. Our evidence is consistent with investors having naively optimistic expectations about the prospects of growth stocks . Lakonishok Shleifer and Vishny 1994 . JEL Classification G12 G14 M41. Keywords Abnormal returns Earnings surprises Growth stocks. We are grateful for the comments of workshop participants at Cornell University Harvard University the University of North Carolina the University of Oregon the University of Pennsylvania the University of Rochester and the University of Washington the 5th Annual Chicago Quantitative Alliance Conference and the 13th Annual Prudential Quantitative Conference. We thank I B E S for providing EPS forecast data. Skinner appreciates financial support from KPMG. All errors are our own. Address all correspondence to Skinner at University of Michigan Business School 701 Tappan Street Ann Arbor MI 48109-1234. Phone 734 764-1239 Fax 734 936-0282 Email dskinner@. Earnings Surprises Growth Expectations and Stock Returns 1. Introduction It is well-established that growth or glamour stocks have historically underperformed other stocks in terms of realized stock returns over the five years after portfolio formation. We show that this phenomenon can be explained by the fact that growth stocks exhibit an asymmetric response to negative earnings surprises. We show that growth stocks perform similarly to other stocks in .

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