Investigate whether buying winners (stocks that have done well in the past) and selling losers (stocks that have done poorly in the past) can generate significant positive returns over future holding periods.
Measure stock rates of return over the past 3 – 12 months.
Rank the stocks from highest to lowest and then divide the sample into deciles. “Losers” are the bottom decile and “winners” are the top decile.
Bernard and Thomas, 1989 Event: Quarterly Earnings Surprises
Measure the abnormal risk-adjusted return after an earnings surprise.
Earnings Surprise =
Actual Quarterly EPS – Forecasted Earnings
If the stock market is efficient, any surprise when earnings are announced should be reflected rapidly in the stock price and (+) or (–) alphas should not be possible trading on the information after it is released.
Larger earnings surprises lead to higher positive abnormal returns.
The upward drift in the stock price continues a couple of months after the earning announcement!
For negative earnings surprises:
Larger negative earnings surprises lead to larger losses as measured by the abnormal return.
The downward drift in the stock price continues a couple of months after the earning announcement!
Evidence of Long-Run Abnormal Risk-Adjusted Returns
After IPOs and after seasoned equity offerings (-) (Loughran and Ritter 1995)
After share repurchase announcements (+) (Ikenberry, Lakonishok, Vermaelen, 1995)
After dividend initiations (+) and omissions (-) (Michaely, Thaler, Womack, 1995)
Loughran and Ritter, 1995 Graph shows the return of the portfolio of firms that have IPOs or SEOs. The idea is that abnormal returns are negative – firms predictably underperform after equity issues.
Ikenberry, Lakonishok, Vermaelen, 1995 Graph shows the return of the portfolio of firms that announce stock repurchase minus the return of several benchmarks. The idea is that abnormal returns are positive and growing.
Michaely, Thaler, Womack, 1995 Graph shows the return of the portfolio of firms that initiate and that omit dividends. The idea is that abnormal returns are positive for initiations and negative for omissions even after the event.
Not easy to directly profit from the January effect.
Tax-loss selling is undesirable.
e.g., Assume an investor with a marginal tax rate of 15% bought $10,000 worth of stock at the beginning of the year. Currently the shares are worth $4,000. If the average January effect is 8% for the first five-day in January, will the investor be better off selling the stock at the end-of-December or at the beginning of January after capturing the 8% January effect?