Earnings Announcements Combined with Stock Repurchases

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

Fundamental reason

The 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 the timing of SEO or repurchase announcement before earnings announcement could be perceived as important information about the future performance of stock during the earnings announcement period.

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Markets Traded
equities

Financial instruments
stocks

Confidence in anomaly's validity
Strong

Backtest period from source paper
1987-2013

Notes to Confidence in Anomaly's Validity

Indicative Performance
25.2%

Period of Rebalancing
Daily

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


Notes to Period of Rebalancing

Estimated Volatility
11.11%

Number of Traded Instruments
100

Notes to Estimated Volatility

estimated from t-statistic 10.81, data from table 7C for period (-10,+15) for analysis excluding small firms


Notes to Number of Traded Instruments

average number of stocks held during one earning announcement period


Maximum Drawdown
0%

Complexity Evaluation
Moderately complex strategy

Notes to Maximum drawdown

not stated


Notes to Complexity Evaluation

Sharpe Ratio
2.27

Simple trading strategy

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

Hedge for stocks during bear markets

No - The 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 the investor holds equities, therefore, his correlation to the broad equity market is very very high).

Source paper
Amini, Singal: Are Earnings Predictable?
- 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).

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