When a company publishes its quarterly or annual results and exceeds expectations, the share price generally rises on the day of the announcement. But have you noticed that most of the time, the stock continues to drift upwards for days, weeks or even months, while investors digest the news? The same thing happens in the opposite direction, when a company disappoints at the time of its earnings report and the stock continues to drift downwards in the sessions that follow. This drift is more pronounced for small-cap stocks, which are generally less liquid and less covered by analysts, so information circulates more slowly.

Now that you know what we're talking about, let's find out what causes this phenomenon.

What causes post-announcement drift?

A very interesting study by Tobias Kalsbach and Steffen Windmüller, from the Technical University of Munich, provides an exciting explanation for this. This study,"Anchoring and Global Underreaction to Firm-Specific News", released in March 2023, was highlighted in a paper by Liberum's Joachim Klement: "Why the post-earnings announcement drift happens". This is apparently due to the psychological anchor provided by the 52-week peak in the share price.

Researchers Kalsbach and Windmüller argue that if a stock is trading near its 52-week high and a company announces positive news, investors are reluctant to update their beliefs about the company and won't start buying shares as much as they would for a stock that's well below its 52-week high. In fact, investors believe that the stock is already "expensive" because it is close to its highs of the past year, and has little room for maneuver despite recent good news. As a result, positive news about a company already trading at the upper end of its 52-week trading range is incorporated more slowly, and the drift after the results announcement is stronger.

Conversely, if a company announces negative news or fails to meet earnings expectations (results below analysts' estimates), but its shares are already traded close to their 52-week lows, investors are also more reluctant to adjust their expectations, and the post-earnings announcement negative drift will also be greater.

How can you take advantage of this to improve your performance?

This effect can be exploited to improve your stock market performance by applying a simple post-earnings announcement drift strategy. Instead of buying stocks with positive earnings and selling stocks with negative earnings, the study recommends you focus on buying stocks with positive earnings AND trading near their 52-week highs. We should also focus on selling stocks with negative earnings AND trading near their 52-week lows. According to Kalsbach and Windmüller's research, this can generate an additional 6.8% alpha per year! That's a significant performance boost for any investor.