In this post we continue our investigation of investor attention around earnings events using price changes as a proxy for attention. We find that jumps on event days are more than double the average return on non-event days.
Overview
In Part 1, we looked at whether investors pay attention to earnings events by focusing on how trading volume changes around events compared to other times. We found that investor activity spikes over 150% on the day after earnings events. One point we’d like to make about this result is that it does not take into account any information about the content of the announcement. In other words, it includes events when companies beat expectations, fall short of them and also report in-line with investor expectations. In a future post, we’ll take a look at how this activity changes as a function of the event content. But for now, we’ll continue the investigation by looking at price changes around events.
Timing is important when dealing with market-moving information so we will begin by recapping a few terms used in part 1:
Jump return: Close price on the event day divided by the close price on the day before the event Reaction return: Close price on the event day divided by the open price on the event day
Event day: The first day when the market is open subsequent to the event release. For events that occur before the market opens, the event day is that day. For events that occur after the market closes, the event day is the next trading day.
In the analysis that follows we make use of our proprietary event dataset during the period 1/1/2012 to 1/1/2017 which contains 57,678 unique events.
Analysis
If the information contained in events is important and being closely watched by investors, we expect to find larger than average price changes relative to other days. The figure below shows that price changes are indeed larger in magnitude on event days. On non-event days, the average absolute close-to-close return for the stocks in our dataset is 1.9%. Meanwhile average absolute value of jump returns is more than double that at 5.2%. Negative jumps tend to be larger in magnitude compared to positive jumps (with 5.4% and 4.9% jump returns respectively).
Results for event reaction returns, which measure price changes from the open to the close on the event day, are presented in the next figure. Reaction returns have an average absolute value of 3.8% compared to 1.7% for open-to-close returns on non-event days. Negative reactions are only 0.1% larger in magnitude than positive reactions. This difference is less pronounced than it was for jump returns.
The presence of large jump returns should not be surprising. After all, we expect that the market responds to news that changes a company’s fundamental value. Meanwhile, the reaction return being so prominent might seem a bit puzzling. However, it provides initial evidence that investors might be over or under-reacting to events. When we build our models for event prediction, one trading opportunity that we focus on is identifying persistent over and under-reactions based on the information contained in events.
Example
To further demonstrate what we are capturing in this analysis we will take a closer look by examining two events. CalAmp Corp. (ticker: CAMP) issued a press release after the market close on 12/21/2016. While their revenue increased from the prior quarter, the non-GAAP adjusted basis net income for the fiscal 2017 third quarter was $0.21 per diluted share (compared to $0.31 per diluted share, in the third quarter of fiscal 2016). The chart below shows the price of CAMP stock from the day before the event through the close on the event day. (Notice the downward spike in price at the open on the event day.)
In response to the results, the stock price dropped from $15.73 at the close on 12/21 to $14.31 at the close on 12/22, a change of -9.0%. During the 5 year period of our analysis this stock had an average absolute close-to-close return of only 1.9% (on non-event days).
On the same day of CAMP's announcement, another company, Micron Technology, Inc. (ticker: MU) also released their quarterly results. Their net income was $0.32 per diluted share, compared to a loss of ($0.01) per diluted share in the prior quarter. Below is a chart showing MU's stock over the two day period spanning the event.
MU's stock price responded very favorably to the news, increasing from $20.58 at the close on 12/21 to $23.19 at the close on 12/22, a 12.7% jump in 1 day.
Cross-sectional Analysis
The results showing jump and reaction returns are useful for illustrating the impact that events have on nominal price returns but it is possible they are driven by outlier events for a small number of stocks in the sample. To establish these results more robustly we present the cross-sectional relative returns for reactions and jumps compared to the respective returns for non-event days. The figure below shows that the average stock has a jump return that is 194% higher than its close-to-close return on non-event days. The reaction return is 129% higher than the open-to-close return on non-event days. These results confirm that investors react to events and that this reaction continues at least through the end of the event day.
Conclusion
In this post we used price changes as a proxy for investor attention to show that event days have much higher activity than non-event days. As we mentioned at the beginning of this post, so far we have presented results that do not rely on the specific content of the events. In a future post, we will use the content to identify “good” and “bad” events. When we focus only on "surprising" events where news differs from the market’s expectations, we find that investor attention is amplified with results more extreme than those presented thus far.
Disclaimer
This material is solely for informational purposes and is not an offer or solicitation for the purchase or sale of any security, nor is it to be construed as legal or tax advice. References to securities and strategies are for illustrative purposes only and do not constitute buy or sell recommendations. The information in this report should not be used as the basis for any investment decisions. We make no representation or warranty as to the accuracy or completeness of the information contained in this report, including third-party data sources. The views expressed are as of the publication date and subject to change at any time. Hypothetical performance has many significant limitations and no representation is being made that such performance is achievable in the future. Past performance is no guarantee of future performance.