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Earnings Surprises vs. Earnings Revisions: Taco Bandito Study

Explore how market under-reactions to earnings surprises and revisions can be exploited for profit, with implementation details, results, and insights on why the strategy works. Learn about the Taco Test and its effectiveness in trading.

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Earnings Surprises vs. Earnings Revisions: Taco Bandito Study

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  1. Earnings Surprises vs Earnings Revisions Taco Bandito: Allen Born Mark Davidson Greg Dayko Stephanie Shayne Ed Shenkan

  2. Overview • Comparison of Surprises to Revisions • Implementation • Results • Why it Works? • Caveats • Taco Test

  3. Description of Strategy • Earnings Surprises: Accounting-Based Earnings Momentum Strategy that exploits market under-reactions to earnings surprises • Earnings Revisions: Accounting-Based Strategy that exploits market under-reactions to revisions in earnings estimates.

  4. Implementation-Surprises • Created portfolios for the months March, June, September, December 1990-1999 • Compute the Surprise (% differential of Actual EPS to Expected EPS) • Long: top 5 % Surprisers • Short: bottom 5 % Surprisers • Equal weighting in longs and shorts • Held portfolios for 6 months

  5. Implementation-Revisions • Created portfolios for the months March, June, September, December 1990-1999 • Compute the Revision (% Change in expected EPS) • Long: top 5 % Revisions • Short: bottom 5 % Revisions • Equal Weighting in Longs and Shorts • Held portfolios for 6 months

  6. Results

  7. Results

  8. Why it works? • Prices of equities for companies recently announcing earnings surprises are mispriced • Investors under-react to changes in earnings • Mean reverting • Anchoring bias

  9. Caveats • We used quarterly EPS estimates for revisions - Not annual EPS • Quarterly changes could be impacted by • Seasonality • Unusual circumstances/Extraordinary Earnings • We only included stocks which are presently in the S&P 500 (i.e. Yahoo instead of Laidlaw) • Used IBES returns

  10. Taco Test • To eliminate seasonality, compared earnings forecast for same quarter of prior year

  11. Questions & Answers

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