Earnings Surprises, Growth Expectations, and Stock Returns:

stocks for which these types of strategies are typically less profitable. 9 Third, our sample
period is concentrated in the 1980s and 1990s, where the MB effect is somewhat weaker
than in the 1960s and 1970s. The unique feature of figure 4 that is important for our
study is that the return differential is clearly concentrated in the second half of each year
(postret) as we see from the steeper slope in that interval, which provides clear evidence
that the MB return differential is concentrated around the release of earnings news. In
fact, returns during the first half of the year (preret) account for less than 20% of the total
predictable returns to the MB hedge portfolio.
Finally, to illustrate the asymmetric response of returns to earnings news for
growth stocks, figure 5 plots quarterly abnormal returns (fullret) against earnings
surprises (FE) separately for growth and value stocks. 10 Figure 5 clearly shows how the
relation between stock returns and earnings surprises differs between growth and value
stocks. For value stocks the relation is fairly symmetric – for both positive and negative
surprises the return/earnings relation looks similar, with returns increasing in the
magnitude of the earnings surprise to a maximum of a little over 5% in absolute value for
both good and bad news. 11 In contrast, for growth stocks we see a very different response
9 The fact that the use of size-adjusted returns yields almost identical inferences to market-adjusted or
market model adjusted returns in our tests supports this explanation.
10 More specifically, to create the plot for ‘value’ and ‘growth’ we take the bottom and top growth quintiles
(as before) respectively and within each of these form 20 portfolios by ranking the observations based on
FE. We then plot the mean returns against the mean forecast error for each of these 20 portfolios and join
these points using the Excel smooth line charting feature.
11 The non-linear, S-shaped relation between earnings and returns is noted by Freeman and Tse (1992), as
well as others since then.
19