We revisit the debate concerning the interpretation given to prior year’s earnings changes in
predicting future earnings as discussed by Abarbanell & Bernard (1992), Francis & Philbrick
(1993) and Easterwood and Nutt (1999). We advance a new specification of this relationship
which distinguishes between earnings reversion and momentum.
On a large UK dataset, we find there is substantial underreaction, particularly in situations of
earnings momentum, approximately six times as large as that identified by Abarbanell &
Bernard. This suggests that analysts behaviour is still a candidate to explain post earnings
announcement drift. We also show that our model performs well relative to a specification
recently proposed by Easterwood and Nutt (1999)
