Past Earnings Trends and Future Earnings – Malaysian Experience

Capital markets appreciate stability and growth. It means that companies which report smooth earnings growth tend to be priced relatively high. In contrast, stocks showing more erratic earnings patterns or reporting declining earnings tend to be valued relatively low. From stock valuation point of view the relevant empirical question is to what extent the past earnings trends are helpful in predicting future earnings changes. In this paper we explore the relationships between past five-year trends of earnings-per-share (EPS) and next-year earnings of companies listed on the Kuala Lumpur Stock Exchange in 2000-2011. We found that companies with the smoothest earnings growth in the last five years tend to provide the slowest next-year earnings growth (and EPS which “misses” the forecast obtained by extrapolating the past trend), while stocks with the strongest past five-years earnings declines tend to revert impressively and to provide relatively fast growth in the following year (and EPS which “beats” the forecast obtained by extrapolating the past trend). Therefore, our research suggests that observed smooth trends of growing / falling historical earnings imply relatively high probability of negative/positive earnings surprise in the following period.