The phenomenon of Post-Earnings Announcement Drift (PEAD) in stock prices has been known for many years. It is an empirical observation of an anomaly in financial markets, where a company’s stock price continues the trend started by the announcement of financial results for a longer period of time than would be justified.
It is one of the strongest phenomena in stock markets, widely studied by economists and financial analysts since the 1960s. PEAD means that the stocks of companies that announce results better than analysts’ expectations typically increase in value for several weeks or even months after the announcement.
Conversely, stocks of companies that announce worse-than-expected results often experience a prolonged decline in value. Importantly, this phenomenon occurs despite the theoretical assumption of market efficiency, according to which stock prices should immediately reflect all available information.
The mechanism behind PEAD is complex, as not all investors can react to new information at the same time, leading to a gradual price correction.
In addition, some analysts may need time to carefully analyze the results and adjust their recommendations, which also contributes to delays in price adjustments.
The third source of movements is the behavior of major market players, who spread out their stock purchases over many days or even weeks in order to avoid triggering too strong a trend.
PEAD thus becomes a rich source of opportunities for investors and traders who can take advantage of these patterns. But it requires in-depth analysis and understanding of both company specifics and broader market conditions.
With the right approach, it can lead to great returns, but, as with any investment strategy, it involves risk and requires caution. Caution and a great deal of knowledge
Part one: the information available on the first day.
In another article “How to catch long trends at the very beginning?” we discussed a situation in which we have an explosion of interest in a company after the announcement of great financial results.
There was an open gap and a very high volume of buying. Everything looked very promising.
But this is only the first day. We don’t know the future and all we can do is evaluate additionally other information about the company and the sector.
We try to pick the best opportunities.
What relevant information on this first day might indicate, increase the likelihood that we will see a longer trend?
Here are some such factors:
Big surprise with results
If a company announces results that differ significantly from analysts’ expectations – either positively or negatively – this can lead to a long-term PEAD. Investors and analysts may then revise their expectations of the company’s future performance, which can affect long-term changes in stock valuations. For example, unexpectedly high earnings may cause investors to revise upward their forecasts for future earnings, which will keep the stock price higher for a longer period of time.
Clarity and quality of the message
Effective communication of financial results and clear presentation of a company’s growth prospects can significantly increase investor confidence. Clear and optimistic messages can strengthen the positive trend of share prices. On the other hand, vagueness or lack of specific forward-looking data can undermine investor expectations and shorten the PEAD.
Industry and market trends
The overall health of the economy and current industry trends have a direct impact on the length and strength of the PEAD. For example, if a company announces strong results at a time when the industry as a whole is experiencing growth, the PEAD effect may be more pronounced and lasting.
Market sentiment, such as general optimism or pessimism, can also modulate the reaction to financial results.
Trading volume
A large trading volume in a company’s shares after the announcement of results is an indication of strong market interest, which may contribute to an extension of the PEAD. Higher trading activity suggests that more investors are reacting to new information, which could lead to more significant and longer price movements.
Revisions and updates from analysts
Analyst reactions, such as changes in recommendations or targeted stock prices, can intensify or prolong the PEAD effect. Positive changes often lead to an increase in share prices, while negative updates can intensify a decline in share values.
Changes in the company’s outlook
Strategic changes in a company’s business, such as new partnerships, acquisitions, investments in innovation or changes in management, can have a major impact on the length and intensity of PEAD. Such announcements are often seen as catalysts for long-term growth, attracting investor interest.
Additional information
If a company announces additional positive information along with its quarterly results, such as an increase in revenue or profit forecasts, this can greatly strengthen and extend the PEAD. Such announcements can further convince investors to make a long-term commitment to the company’s stock, which keeps the share price high.
Read the whole article in newest issue of New City Trader magazine (it’s free!):
This is a very special issue. Inside, you will find 2 SUPER interviews with extraordinary people from the industry.
• The first one with Alfonso Peccatiello. Alf is a trader and CEO of “The Macro Compass”, previously he was Chief Investment Officer at ING Germany, where he managed a $20 billion portfolio. We talk about the importance of macroanalysis and how to use it in everyday trading. Highly recommended!
• The second great conversation I had was with Moritz Czubatinski. Moritz is a trader with almost 20 years of experience and co-founder of “Edgewonk” – a professional trading journal. He talked about how indispensable it is to keep a trading journal, how with its help you can literally improve your results in a weekend. Great talk!
And more:
How to catch long trends at the very beginning
Indicators showing the interest of large funds in the company’s shares
Ark Investment on AI
The key trait of a trader: discipline? Wel, not at all!
What can make the movement continue after the initial explosion?
It is the trader who is profitable, not the system!
Interview with Andrea Unger
The biggest idea ever!
