Naïve Earnings Growth Extrapolation

Using the unique financial reporting format in China, where quarterly earnings are reported on a year-to-date basis, we test behavioral finance models featuring fundamental extrapolation. We show that stocks with the strongest past year-to-date earnings growth experience a significant price run-up during the five trading days before their earnings announcements and a significant return reversal afterward. The effects are more pronounced for stocks with a larger retail clientele and less analyst coverage. Corroborating evidence from retail investor net buying demand suggests that investors naïvely extrapolate the salient but less informative year-to-date earnings growth when forecasting the upcoming earnings