November 19, 2018

Earnings Release Headlines: The Problem With Numbers

Nearly 30% of companies highlight quantitative information at the top of their earnings release – and after writing my fair share of headlines, I can understand why! Numbers are succinct, eye-catching, and (presumably) accurate. But a recent study shows that this practice may lead to some pretty big swings in stock price – and might foreshadow lower earnings over the long-term. This article summarizes the findings – here’s an excerpt:

The study of more than 17,000 earnings releases over an 11-year period finds that increasing headline salience (for example, when earnings exceed forecasts, headlining by how much), gives a hefty lift to a firm’s stock price beyond the rise that is normally occasioned by good news. On average, adding one strong performance number to a headline increases a results-inspired boost by an extra one third in the three-day period around the announcement.

Citing psychology research, the professors see this extra boost as due to the effectiveness of headline numbers in attracting investor attention. In addition, “an initial favorable impression can lead investors to underweight contradictory information elsewhere in the report.”

But investors beware: after a quick stock-price lift, salience likely portends a considerable reversal over the 60 days following the earnings announcement, a reversal greater than the initial boost that the salience bestowed. In other words, as the professors write, “investors not only undo their initial reaction due to salient headlines but even revise their beliefs in the opposite direction in the subsequent period.” In sum, “headlining quantitative information incites investor overreaction to the earnings news at the time of the earnings announcement…This suggests that headline salience misleads investors.”

And here are some other interesting takeaways:

– Companies that flaunt strong current results in headlines tend to have lower long-term earnings (beyond the current quarter)

– High salience is strongly correlated with increased insider stock sales in the month following earnings announcements and also with the recent vesting of executives’ stock

– Both 3-day stock returns and 60-day reversals increased with greater headline salience, both being higher as the number of headline statistics increased (for example, from zero to one or from one to two).

– While headline salience is effective when earnings exceed analyst forecasts, that is not the case when they do not. In other words, greater salience does not spur investor interest when earnings barely meet or fall short of predictions.

– Headlined earnings numbers have more effect when expressed as percentages than when stated in dollars.

Farewell to Penny Stocks?

I mentioned in a blog last month that there are an estimated 10k publicly-traded microcaps – but most aren’t listed on an exchange (h/t to Adam Epstein for that stat). But we might see a decline in those numbers if the secondary market evaporates – and there are signs that it’s heading in that direction. Here’s the intro from this Forbes op-ed by Richard Levick:

An event that rather significantly affects the financial markets has just occurred without much if any fanfare in the financial press. Bank of America’s Merrill Lynch announced that, as of September 30, it will not allow clients to sell microcap stocks, known as penny stocks, without a regulatory review and will outright ban sales of the riskiest ones. The bank had already discontinued purchases in July.

If enough other financial institutions follow suit, the penny stock market could disappear altogether. As of this writing, Morgan Stanley and UBS have not followed Merrill’s lead, according to sources cited by CNBC reports, but investors sense a chill wind has begun to blow. Shares from companies valued under $300 million and traded for under $5 on an over-the-counter market are the ones affected – in other words, virtually the entire microcap market.

By the way, catch Richard Levick in our upcoming webcast: “How Boards Should Handle Politics as a Governance Risk“…

Transcript: “Proxy Solicitation – Nuts & Bolts”

We have posted the transcript for our recent webcast: “Proxy Solicitation – Nuts & Bolts.”

Liz Dunshee