Confirming or Conflicting Sales and Earnings Signals

Abstract

This study examines market reactions to the preliminary earnings announcements of companies, when the announcements provide confirming or conflicting signals about sales and profit growth. Consistent with intuition, the authors show that when the signals are positive and confirming, i.e., when both sales and profits increase substantially, the market reaction is positive and significantly different from zero. Similarly, when the signals are negative and confirming, i.e., both sales and profits decline or grow slowly, the market reaction is negative and significantly different from zero. The authors then explore the market reactions when the sales and earnings signals conflict. When sales decline or grow slowly but profits grow substantially, the market reaction is different for value and growth firms. The market reaction of value firms is positive and statistically different from zero, indicating that market participants favor value companies that are able to control expenses even when they are facing a decline or slow growth in sales. Market participants react negatively, however, to growth companies that report a decline or slow growth in sales even if profits grow significantly. The authors do not find any clear differences between value and growth firms for the conflicting signals of high growth in sales but low growth in earnings.