Financial Education

One explanation for stock price momentum is that investors react slowly to changing circumstances. In the May/June 2007 Financial Analysts Journal Ilya Figelman studies the interaction between earnings measures and past stock returns.

Large-cap companies with high ROE but poor recent stock returns significantly underperform the market and companies with poor stock returns but low ROE. Figelman suggests that the poor recent returns for such companies results from some investors recognizing that profitability has peaked for such firms, while the continued underperformance suggests that it has not been efficiently priced by all investors.

Companies with poor past returns and poor earnings quality (high accruals) significantly underperform both the market and those companies with poor past stock returns and high earnings quality. Therefore, investors also appear to react slowly to earnings manipulation.

For more information, see all articles on: Accounting, Common Size Analysis, Financial Statement Analysis, Fundamental Analysis, Investing in Stocks, Investment Returns, Ratio Analysis, Security Selection, Valuation

See also:

Scaled Earnings Surprise

Adjusted Earnings Yield

Earnings Surprise and Future Excess Returns

Growth Investment Styles

Credit Rating and the Momentum Anomaly