Exhibit 1: Stronger Than Expected Earnings Surprise and Factor Returns
Regression Coefficients
Current month Next month
Debt/equity +0.75 –0.60
Size –0.30 +1.20
Based on data from Exhibit 1, Adamson should conclude that:
A)
small companies would outperform large companies in the current month given a larger-than-expected earnings surprise.
B)
companies with high debt/equity ratios will outperform next month given a larger-than-expected earnings surprise.
C)
if an earnings surprise comes at the end of the month, then the current month’s signals are most useful.
Schweser Answer: A. Based on the small negative coefficient of –0.30, this is insignificant and small companies would outperform large companies in the current month given a larger-than-expected earnings surprise announcement.
Companies with high debt/equity ratios will outperform next month given a larger-than-expected earnings surprise is not correct because given the negative coefficient of –0.60 next month for the debt/equity ratio, companies with high debt/equity ratios would underperform low debt/equity ratio companies given a larger-than-expected earnings surprise announcement.
If an earnings surprise comes at the end of the month, then the current month signals are most useful is not correct because if an earnings surprise comes at the end of the month, then the next month’s signals are the most useful or relative performance.
In my opinion, neither one of these answers is correct. What deems the -.30 coefficient as “insignificant” ??