Earnings Announcements Combined with Stock Repurchases

Earnings announcement period is important time for many equity traders. It is time when most of the stocks move with a higher volatility which offers bigger potential for profit. We present interesting research paper which helps to increase odds of correctly pick outperforming (and underperforming) stocks during this period. Paper shows that timing of stock repurchase announcement and secondary equity offering (SEO) announcement is important predictor of performance during earnings announcement. Managers have ability to time stock repurchase and SEO announcement and research shows they choose to buyback stocks when they expect good earnings announcement and they prefer to execute SEO before bad earnings. Therefore investor could look for this indicators and build long only (with the help of information from stock repurchase announcements) of long-short (short leg with a help from SEO announcement date) trading portfolio with an attractive characteristics. We insert long-only description into our database (as it is easier to build and trade) but we recommend to review also long-short version of this strategy described in the source academic paper.

Fundamental reason

Academic paper states that it is generally accepted that managers have more information about the firm than investors. Given this information asymmetry, managers can make informed decisions about corporate actions such as equity offerings or repurchases. The announcement of stock repurchase or secondary equity offering is voluntary and can be easily moved by a few weeks or months. Therefore timing of SEO or repurchase announcement before earnings announcement could be perceived as important information about future performance of stock during earnings announcement period.

Markets traded
equities
Confidence in anomaly's validity
Strong
Notes to Confidence in anomaly's validity
Period of rebalancing
Daily
Notes to Period of rebalancing
Number of traded instruments
100
Notes to Number of traded instruments
average number of stocks held during one earning announcement period
Complexity evaluation
Moderately complex strategy
Notes to Complexity evaluation
Financial instruments
stocks
Backtest period from source paper
1987-2013
Indicative performance
25.20%
Notes to Indicative performance
per annum, annualized return (geometrically, four earnings announcement periods per year, average return 5,78% per announcement), data from table 7C for period (-10,+15) for analysis excluding small firms
Estimated volatility
11.11%
Notes to Estimated volatility
estimated from t-statistic 10.81, data from table 7C for period (-10,+15) for analysis excluding small firms
Maximum drawdown
not stated
Notes to Maximum drawdown
Sharpe Ratio
2.27

Keywords:

trading earnings, earnings announcement, stock picking, financial statements effect

Simple trading strategy

The investment univese consists of stocks from NYSE/AMEX/Nasdaq (no ADRs, CEFs or REITs), bottom 25% of firms by market cap are dropped. Each quarter, investor looks for companies which announce stock repurchase program (with announced buyback for at least 5% of outstanding stocks) during days -30 to -15 before earnings announcement date for each company. Investor goes long stocks with announced buybacks during days -10 to +15 around earnings announcement. Portfolio is equally weighted and rebalanced daily.

Hedge for stocks during bear markets

No - Selected strategy is designed as a long-only therefore it can't be used as a hedge against market drops as a lot of strategy's performance comes from equity market premium (as investor holds equities therefore his correlation to broad equity market is very very high).

Source Paper

Amini, Singal: Are Earnings Predictable?
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2589966
Abstract:
If managers use their superior information to time a firm’s corporate actions, it is likely that equity issuance will precede bad earnings while stock repurchase announcements will precede good earnings. Consistent with this conjecture, we find evidence of market timing and earnings predictability. The market reaction to earnings following repurchase announcements is statistically and economically significantly higher by 4.56% than earnings following SEO pricings over a 25 trading day window (-10, 15).

Hypothetical future performance

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