Revisiting the earnings-price effect: The importance of future earnings

Ascertaining the value of future earnings is one of the major objectives for investors to forecast and thereby determine current stock prices. This paper examines whether predicting future earnings can create risk-adjusted returns. We find that the risk-adjusted returns of portfolios constructed on future E/P ratios are superior to those constructed on past E/P ratios under the four-factor model. The risk-adjusted returns increase monotonically with the number of future quarters used to compute the E/P ratios. Moreover, the risk-adjusted returns for the firms with high E/P ratios are positively related to the changes between past earnings and future earnings. Overall, forecasting future earnings precisely would significantly enhance the risk-adjusted returns of portfolios.