Stocks with high expected returns, called lottery stocks, tend to outperform in the days ahead of an earnings announcement and underperform in the days following the announcement.
Lottery stocks, those with high expected returns, tend to experience an inverted V-shaped return pattern around earnings announcements. Such stocks tend to outperform in the days ahead of an earnings announcement and underperform in the days following the announcement. Though many individual stocks may experience similar return patterns, lottery stocks tend to be unique as a group in incurring such a pattern of returns.
Specifically, during the five-day period leading up to earnings announcements, lottery stocks gain 0.52% more than non-lottery stocks. This gain is reversed during the five days following the earnings announcement, with lottery stocks underperforming by 0.75%. This return pattern is unique to the 11-day period surrounding earnings announcements; it is not found to be a repeatable pattern during random non-earnings periods.
The anomaly is more pronounced among companies that report early in an earnings season, and weakens for companies that report later in an earnings season. This is consistent with a pattern of early reporters having good news and more media attention, and late reporters having bad news and less attention.
These observations are based on an analysis of more than 600,000 earnings announcements made between January 1972 and December 2014. Lottery stocks are defined as having negative returns between the maximum daily return and future returns, expected stock-specific skewness (relatively less symmetry in returns), relatively lower prices, a high predicted probability of jackpot (extremely large) returns and high volatility.
Trading behavior among individual investors is attributed as the reason for this anomaly. An increased imbalance in the buy-initiated and the sell-initiated small-trade volume occurs ahead of the earning announcement. This imbalance is “generally significantly larger among lottery stocks than among non-lottery stocks,” say the study’s authors. At the same time, demand for out-of-the-money call contracts—options that will only be worth exercising if the stock’s price rises by a large enough amount—increases ahead of the earnings announcement and decreases afterward.
Data from institutional traders further supports the influence of individual investors. The earnings-related lottery stock spread is more evident among shares of companies ranking in the bottom 50% of institutional ownership.
While this study explains the return behavior of lottery stocks around earnings announcements, it can be very difficult to exploit. The very short window of time requires frequent trading, with costs potentially offsetting gains.
Source: “Time-Varying Demand for Lottery: Speculation Ahead of Earnings Announcements,” Huijun Wang, Jianfeng Yu and Shen Zhao, SSRN, November 2016.
AAII Stock Ideas
Investor Professor
Growth Investing
Joseph Gill from FL posted over 9 years ago:
You need to log in as a registered AAII user before commenting.
Log InCreate an account