Monday, May 19, 2008

Lag between price and earnings

Another exciting lesson when comparing historical performances of groups of stocks: don't forget to account for the lag between fiscal year-end results, and public knowledge of those results!

To use an example, the Compustat database might tell you that a company's stock price was $40 on December 31st 1980, and EPS was $4 at year-end December 31st of the same year. But when the stock was $40 at the end of the year, investors did not yet know that EPS would be $4. They were most likely still trading on the last twelve months of EPS, which would not have included the 4th quarter of 1980.

What to do? Introduce a lag on price. Compustat will spit out the exact end of the fiscal period, so add some time onto that for the market to come to terms with the results of the fiscal year end: Grab your price 1-2 months later than the fiscal year-end to get a more accurate read on what data investors were trading on!

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