left background showing woman speaking
right background showing woman listening

The Earnings Whisper Grade

The Earnings Whisper Grade gauges the likelihood of a stock's price drifting up or down in the 91-day window following its earnings release.

  • The Post-earnings Announcement Drift (PEAD) remains the only market phenomenon to withstand the test of time, consistently demonstrating a predictable impact on stock prices in the aftermath of earnings announcements.
  • The significance of a company beating its earnings estimate is deeply tied to investor sentiment, as an earnings beat can only drive significant market reactions if it alters the existing market perception about the company's future prospects.
  • This phenomenon has persisted for more than 50 years because it is underpinned by human behavior, which is enduring and unchanging.
  • By integrating the market's true earnings expectations with investor sentiment, the Earnings Whisper Grade has been a notably superior measure of PEAD.
  • Over the past 20 years, stocks with an A+ grade have returned 365% per year over the S&P 500

The Post-earnings Announcement Drift is THE Quantitative Analysis

The foundational idea underpinning the Earnings Whisper grade originates from a market phenomenon unearthed by Ray Ball and Philip Brown in 1968, dubbed the Post-earnings Announcement Drift (PEAD). Their groundbreaking research, published in the Journal of Accounting Research under the title "An Empirical Evaluation of Accounting Income Numbers," set the stage for what we know today as Quantitative Financial Analysis.

Ball & Brown uncovered that a single financial event could potentially influence a stock to either overperform or underperform the stock market in the future. Their work notably contradicted the Efficient Market Hypothesis, which claims that all news is instantly factored into stock prices. This pioneering paper fundamentally challenged the then-prevailing belief in the accounting field that investigating the impact of financial statement information on share prices was unproductive.

Advancing about five decades since the discovery of PEAD, the financial world has seen a significant rise in the popularity of quantitative analysis, with numerous theories and strategies emerging, each asserting its own unique data point or trend that promises to outpace the market. These concepts often venture into abstract territory, such as the notion that tracking elephant migration patterns in India could yield a 50-basis point edge over the market. However, amidst this proliferation of increasingly complex strategies, the enduring reliability of PEAD stands apart, holding its ground as the one consistent, time-tested phenomenon that has continually proven its mettle across varying market conditions. These alternative strategies, while appealing to the adventurous or highly diversified investors, have yet to demonstrate the consistent predictive power inherent in the Post-earnings Announcement Drift.

Read more about the Post-Earnings Announcement Drift

The Evolving Measure of Market Expectations

However, Ball & Brown faced a significant obstacle in 1968: a reliable means of determining market expectations before an earnings release. Today, that problem has largely been solved, and various studies continue to support the existence of the PEAD phenomenon. For instance, Victor Bernard and Jacob Thomas, in their 1990 research paper "Evidence that Stock Prices do not Fully Reflect the Implications of Current Earnings for Future Earnings," used the average of financial analysts' earnings estimates.

Yet, another reality surfaced in the wake of Bernard & Thomas' research: the consensus earnings estimate doesn't necessarily mirror the market's expectation. In their 1999 paper "Whisper Forecasts of Quarterly Earnings per Share," Mark Bagnoli, Messod Daniel Beneish, and Susan Watts unveiled that Whisper Numbers are not only more accurate than consensus estimates but are also better proxies for price reactions.

Read more about the Earnings Whisper ® number

The Earnings Whisper ® number is the market's true earnings expectation, but measuring expectations goes beyond a number and often incorporates anticipation of a "beat and raise", increased subscriber growth, or other non-numerical parameters that significantly impact investor sentiment. Moreover, these complex expectations of professional analysts may not always be in sync with individual investors. Therefore, any unexpected deviation from these expectations can lead to a reassessment of a stock's valuation, thereby inducing the observed post-earnings announcement drift.

Investor Sentiment is Human Behavior

In essence, financial markets are a reflection of collective human behavior. As renowned trader Jesse Livermore once said, "Wall Street never changes, the pockets change, the stocks change, but Wall Street never changes because human nature never changes." This fundamental truth underscores the persistence of human emotions - such as fear, greed, and surprise - in shaping market movements.

The narrative of markets being a manifestation of human behavior becomes particularly salient when considering surprising events that deviate significantly from prevailing investor sentiment. As humans, our natural reaction to an unexpected event is reassessment and adjustment of our beliefs, actions, and, in the context of markets, our investment decisions. When earnings announcements defy investor sentiment, it creates a ripple effect in the market, leading to larger post-earnings-announcement drifts as investors recalibrate their positions to align with the new reality.

In his classic work "Extraordinary Popular Delusions and the Madness of Crowds," Charles Mackay elucidates this phenomenon as he recounts numerous historical instances of collective hysteria. Much like these historical instances, investor sentiment can sometimes deviate from fundamental realities, setting the stage for potential surprises that challenge these sentiments. Identifying these outliers, where reality diverges sharply from collective expectations, and understanding their impact on market behavior can provide valuable insights for market participants, hence adding a robust dimension to the Earnings Whisper grade methodology.

The Earnings Whisper Grade – a cutting-edge tool for identifying PEAD

The Earnings Whisper Grade encapsulates a combination of an improved measure of earnings expectations and an enhanced understanding of investor sentiment, creating a refined tool for identifying Post-earnings Announcement Drift (PEAD) and putting it into a straightforward, actionable tool for investors.

Our system delves into the quality of a company's reported earnings, juxtaposing it against our composite measures of expectations. It assigns a grade that directly corresponds to the deviation, painting a clear picture of performance versus expectation. Naturally, market dynamics can cause short-term variations, with weaker stocks occasionally outperforming stronger counterparts. However, historical analysis dating back to 2002 reveals a consistent pattern: companies earning a D grade have consistently outperformed those earning an F, while both sets underperform the overall stock market. Those receiving a C grade typically move with the market. Notably, those that secure a B grade or higher, consistently outperform the overall market.

The A+

Back in 2015, when we first unveiled the Earnings Whisper Grade, it was largely a back-tested concept. Despite being rooted in numerous quantitative studies and our in-depth analyses, it had yet to be proven in real-time market conditions. Fast forward to the present, and the system has demonstrated a clear hierarchy of performance among the grades and spectacular results for those stocks earning the coveted A+ grade.

Investing in companies that score an A+ immediately following their earnings release and selling them the day before their next earnings report has delivered extraordinary returns, significantly outperforming the overall stock market. It's an outcome that has far surpassed theoretical expectations, reinforcing the Earnings Whisper Grade as a reliable and robust tool for investors.

In the rapidly evolving world of investing, the enduring reliability of the Post-earnings Announcement Drift (PEAD) offers a pillar of consistency, making it a trusted cornerstone for sound investment strategies. The Earnings Whisper Grade has proven to be a remarkably effective tool in predicting this phenomenon, integrating both market expectations and investor sentiment to reliably gauge the drift potential of a stock post-earnings announcement. The grade's track record speaks for itself, with stocks earning an A+ grade consistently delivering exceptional returns. This exceptional performance underscores the significance of this innovative tool, which has successfully weathered real-time market conditions over the past eight years, consistently outperforming theoretical expectations. It is a testament to the robust, time-tested science behind the Earnings Whisper Grade, making it an invaluable tool for investors seeking consistent returns in a dynamic market landscape.