Forming trading strategies from market efficiency assumptions may not be an easy task, but that hasn't stopped UQ Business School researcher Paul Schneider from trying.
Investors have seen share prices rise or fall following a company earnings announcement, but Mr Schneider is determining whether these observations are correct by analysing trading data for every company listed on the Australian Stock Exchange for the past 19 years.
"My study is looking at extreme company earnings relative to expectations and forming strategies using these companies that have experienced an earnings surprise," he said.
"If a company reports what we expect there's likely to be little share price change. But if we look at companies that report well above or below what was expected, we should observe a prompt change in their stock price to reflect the new information."
"However this quick adjustment is often not witnessed, particularly in small stocks with poor analyst following. The controversial issue my study considers is that these companies' stock prices can be sluggish in responding to the extreme news. This gradual absorption of news is reflected in the drift of stock prices, known as momentum."
While a lot of research into the matter has been done and documented in the United States, Mr Schneider said the link between price momentum and earnings momentum hasn't been examined in Australia.
"Price momentum is the continuation of prices based on prior stock returns. Earnings momentum is also the drift of prices but in response to prior earnings performance. I believe this study will make a significant contribution to the Australian momentum literature given earnings momentum has not specifically been done in this country," he said.
The Commerce Honours student said that a typical momentum strategy involves buying stocks that have previously performed well in relation to expectations and short-selling stocks that have recently underperformed.
He also said this reliance on short selling, often in small and non-liquid stocks, makes these strategies difficult to implement and heightens the need for quality research.
Mr Schneider believes his study will complement much of what has been done in the price momentum literature.
"We know there is a link between price and earnings momentum. I want my study to demonstrate the extent to which earnings and price momentum occur in the same stocks."