Biggest Surprise in Shock Profit Warnings? Lack of Surprise

  • Academic study found 60% of warnings signaled by market move
  • Finds evidence of information leakage or market anticipation
Photographer: David Goddard

When is a surprise profit warning not a surprise? Most of the time, it seems.

The majority of unscheduled U.S. profit warnings show evidence of information leakage or market anticipation, according to a study in the current edition of the Journal of Economics and Business, an academic publication from Relx Group.

More than 60 percent of companies underperformed the market in the month before they warned on profit. The study of 1,961 statements issued by U.S.-listed firms from 1995 to 2012 found they lagged by an average of 5.3 percent.

“The negative abnormal returns start to accumulate prior to the announcement, indicating the occurrence of information leakage or market anticipation, or both,” according to the authors, who include Professor of Finance Raymond Cox of Thompson Rivers University in Kamloops, Canada.

Bad news, however well-anticipated, still packed a punch with shares underperforming an average of 13.4 percent the day of a company’s warning, according to the research. That compares with an average relative decline of 1.2 percent for a scheduled earnings report that missed expectations.

The study also found:

  • Profit warnings have a bigger impact during periods of economic growth than during periods of economic contraction.
  • The impact of profit warnings has declined over time as the Sarbanes-Oxley Act has integrated into business. (Sections of the law require officials to give timely disclosure on material changes in financial condition.)

The findings chime with prior research. A 2011 paper in the journal Financial Management also showed evidence of information leakage, albeit through “unintentional” signals. The risk a company will inadvertently telegraph its moves becomes more pronounced if it is smaller, preparing more guidance, and when there’s a bigger gap since it last reported.

If you don’t like surprises, relax. The current earnings season has gone well so far. Seventy-five percent of the S&P 500 companies that have reported to date have beaten earnings estimates, with an average “beat” of more than 3 percent, according to data compiled by Bloomberg.

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