PEAD Strategy - A short Term Market Anamoly

And How to potentially exploit this Gap !

I heard about PEAD - Post Earnings Announcement drift on a Podcast (link at bottom).

When the guest highlighted the robustness of the strategy by saying that it worked : “across counties and across timeframes”, I decided to look into it.

I read 2 white papers on the PEAD Strategy (link at bottom of post) and based on the learnings, I will try to break-down the concept of PEAD - Post Earnings Announcement drift.

Let’s Go ! 🏁

The Post-Earnings-Announcement Drift (PEAD) is a ‘Market Anomaly’ where stock prices tend to continue moving in the direction of an ‘earnings surprise’ (for 2-3 Quarters) after the earnings announcement has been made.

This suggests that the market does not immediately price in the information contained in earnings announcements, leading to a delayed reaction and subsequent drift.

I believe that that the reaction times has becomes faster but there seems to be enough evidence that this strategy still works ! (Read White Paper on Indian Data (2018), link at bottom)

BUT why does PEAD even exist?

Well, nobody really knows for sure but we have a few possible explanations :

👉🏽 Delayed Response: Investors might not react immediately to earnings surprises, causing a gradual price adjustment.

👉🏽 Information Assimilation: Investors might take time to fully understand and digest the implications of earnings reports.

👉🏽 Investor Behaviour: Behavioural biases like inattention or overreaction can contribute to the delayed response.

However, bear in mind that any strategy that has worked and is used more and more widely is likely to stop working.

I cannot comment on when this is likely to happen with PEAD but its something to bear in mind.

According to Mr. Prabhakar Kudva (Podcast Guest, link at bottom), 3 basic conditions must be present for PEAD to work

🔑 Neglect - The Stock must be neglected

🔑 Blockbuster Earnings Growth - (Definition is BLOCKBUSTER is not clear but my guess is nothing short of 30%

🔑 Sector wide Earnings Growth - If other companies in same or similar sectors are also experiencing BLOCKBUSTER earnings growth it gives more comfort that the earnings growth may sustain.

Let’s checkout a few examples :

• Karnataka Bank Q2FY2023 YoY Profits Went up 3X, Stock Moved 64% in 2 Months from 24th Oct 2022

• Data Patterns Q4 FY2022 YoY Profit went up 4X, Stock moved up 2X in 60 Days.

• Canara Bank Q2FY2023 YoY Profit went up 2.5X, Stock moved up 60% in 60 Day

• Ujjivan SFB went from being in losses for 3 consecutive quarters to hitting a profit of ~ 128 Cr in March 2022 Quarter. I was not tracking the PEAD signal at the time but I did eventually invested because I picked up other signals such as a depressed valuation and turning banking sector.

I think in addition to examples that worked, it would’ve been useful to have case studies where PEAD failed to work despite blockbuster earnings growth post a period of neglect.

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What if we Reverse engineer the Super-Performer Stocks (100% Return in 1 year) and check whether Earnings Growth was indeed a contributing factor?

Would that help us correlated Blockbuster PAT Growth with ‘Super-performance’?

Based on a list of 381 Stocks that gave a 100%+ Return in the last 1 year, we learn that :

Link to Sheet (Click here)

⚡ Stocks from 65 Industries doubled in 1 year : It was quite a broad rally in that sense.

⚡ Median Y-O-Y Quarterly PAT Growth is 105% AND Minimum Y-O-Y Quarterly PAT Growth is 25.2% for KFin Technologies

⚡ Median Average 3 Year PE was 24.4X Vs. Current PE of 39.79X : 63% GROWTH in Multiple Expansion

(Median used because outliers skew the average)

Therefore, PAT GROWTH + Multiples Expansion both contributed to outsized gains ! (Not surprising)

Even the starting Market Cap of this ‘Super-Performer’ group seems to be well distributed with 50% of the companies falling in the 500-2500 Cr Category.

The above data study does NOT strictly seek out for existence of PEAD Strategy in the academic sense but it does highlight a Simple principle :

Earnings growth drive Stock prices !

Blockbuster Earnings Growth drive Blockbuster Stock Returns

Of Course, in any given year despite robust earnings growth PE Multiples could contract and the stocks may end up flat.

So ‘Super-performance’ is a partially God (market) given and partially Earnings Growth driven.

In the last 1 year both combined together to give a super-performance 🚀 Year

381 Stock doubling in 1 year presently an optimistic case for Active Investing, which makes me wonder :

How many stocks double every year?

Would the no. of stocks doubling in 1 year fluctuate widely?

How wide is this range? 🤔🧐

A thought for another post.

Circling back to PEAD, we can conclude there seems to be evidence of surprising and HIGH PAT growth driving stock prices and that this ‘drift’ may last for 2-3 quarters even more.

Exactly how one would go about building/experimenting with a portfolio around this strategy would be an Interesting next step.

Let me know in the comments if we should explore this together in future posts?

Thank you so much for reading 💛

Rahul

Research :

• Stoic Talks Podcast with Mr. Prabhakar Kudva link :

  PEAD white Papers :

• 50 Year Study on PEAD

• PEAD in the Indian context (2018)