Earnings Surprises, Growth Expectations, and Stock Returns:

and growth stocks is concentrated in firms reporting negative earnings surprises.
Because only 50% of securities are assumed to report negative surprises, the average
return differential between value and growth stocks is magnified to 4% for these
securities, thus maintaining the average differential across all stocks of 2%. The key
feature of the returns in figure 2 (b) is that the differential returns from growth and value
stocks are only realized during quarters when negative earnings surprises are reported.
Figure 2 (b) illustrates the first and second of the three predictions that we test in this
study. First, we see a large asymmetric negative reaction to negative earnings surprises
in growth stocks. Second, there is no evidence of a value/growth return differential in
stocks reporting positive earnings surprises, indicating that the value/growth return
differential is entirely concentrated in firms reporting negative earnings surprises.
Our third and final prediction is that the differential returns to growth and value
stocks are concentrated around the release of earnings news. Evidence in support of this
prediction corroborates the link between the differential return behavior and earnings
surprises. Such evidence is not presented in either Basu (1977) or Dreman and Berry
(1995). Past research by Laporta et al. (1997) and Bernard et al. (1997) focuses on the
returns to growth and value stocks during short (2-3 day) windows centered on quarterly
earnings announcement dates. However, as in the Rainforest Café example, investors
frequently receive earnings information ahead of the formal earnings announcement date,
and this ‘preemption’ of earnings news is more likely in the case of adverse earnings
surprises. Preemption occurs for two reasons. First, there has been a growing trend for
management to preannounce earnings [Skinner (1994, 1997), Kasznik and Lev (1995),
and Soffer, Thiagarajan and Walther (1999)]. The evidence indicates that
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