Do Markets Accurately Price Earnings Momentum?
Prior research on meeting or beating earnings targets documents that firms with earnings momentum are awarded with valuation premiums. However, it still leaves unclear from the literature why this is the case. This study attempts to provide the rational explanation for such market rewards. We mathematically show that earnings momentum can be obtained through high earnings persistence or strong economic shocks. However, our empirical evidence suggests that earnings momentum is a reflection of high earnings persistence. It further reveals that longer duration of earnings momentum is associated with higher fundamentals-driven earnings persistence. More importantly, our findings indicate that valuation premiums are exclusively assigned to earnings momentum determined by strong firm fundamentals, not momentum itself. Our conclusion supports the view that markets are rational.
Keywords - Component; Valuation Premiums; Earnings Momentum; Earnings Persistence; Firm Fundamentals