Starbucks Financial Statement Analysis
ACCOUNTING HORIZONS Vol. 18, No. 4 December 2004 pp. 263XXX
How Do Earnings Numbers Relate to Stock Returns? A Review of Classic Accounting Research with Updated Evidence
D. Craig Nichols and James M. Wahlen
SYNOPSIS: An extensive body of academic research in accounting develops theory and empirical evidence on the relation between earnings information and stock returns. This literature provides important insights for understanding the relevance of financial reporting. In this article, we summarize the theory and evidence on how accounting earnings information relates to firms stock returns, particularly for the benefit of students, practitioners, and others who may not yet have been exposed to this literature. In addition, we present new empirical evidence on the relation between earnings and returns by replicating and extending three classic studies using data from 1988 through 2002. Specifically, we first demonstrate the relation between earnings changes and stock returns, replicating Ball and Brown (1968), and we compare that relation to the relation between changes in cash flows from operations and stock returns. Second, we demonstrate the impact of earnings persistence on stock returns, extending findings from studies such as Kormendi and Lipe (1987), and highlighting the effects of differences in persistence across earnings increases and decreases. Third, we provide evidence to assess the efficiency with which the capital markets impound quarterly earnings information into share prices, showing that the post-earnings-announcement-drift results of Bernard and Thomas (1989) extend to recent data.
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INTRODUCTION arnings (or more precisely, accounting net income) represents the bottom-line accounting measure of firm performance. A firms earnings number is an accrual accounting measure of the firms profit or loss from business activities and events during a quarter or annual period. A firms earnings number represents an accounting measure of the
How Do Earnings Numbers Relate to Stock Returns? A Review of Classic Accounting Research with Updated Evidence
D. Craig Nichols and James M. Wahlen
SYNOPSIS: An extensive body of academic research in accounting develops theory and empirical evidence on the relation between earnings information and stock returns. This literature provides important insights for understanding the relevance of financial reporting. In this article, we summarize the theory and evidence on how accounting earnings information relates to firms stock returns, particularly for the benefit of students, practitioners, and others who may not yet have been exposed to this literature. In addition, we present new empirical evidence on the relation between earnings and returns by replicating and extending three classic studies using data from 1988 through 2002. Specifically, we first demonstrate the relation between earnings changes and stock returns, replicating Ball and Brown (1968), and we compare that relation to the relation between changes in cash flows from operations and stock returns. Second, we demonstrate the impact of earnings persistence on stock returns, extending findings from studies such as Kormendi and Lipe (1987), and highlighting the effects of differences in persistence across earnings increases and decreases. Third, we provide evidence to assess the efficiency with which the capital markets impound quarterly earnings information into share prices, showing that the post-earnings-announcement-drift results of Bernard and Thomas (1989) extend to recent data.
E
INTRODUCTION arnings (or more precisely, accounting net income) represents the bottom-line accounting measure of firm performance. A firms earnings number is an accrual accounting measure of the firms profit or loss from business activities and events during a quarter or annual period. A firms earnings number represents an accounting measure of the
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