The concurrent earnings-change/return-change effect gives security analysts a reason to try to forecast earnings. If the market had been efficient in anticipating—and pricing—year-ahead earnings changes, attempts to forecast these changes would be a waste of time. But, happily for forecasters, the existence of the concurrent earnings-change/return-change effect shows that anyone who could have accurately grouped 500 to 800 of the largest-capitalization stocks into five portfolios on the basis of year-ahead relative earnings changes could have reaped extraordinary rewards.
Actually, it is important that to have been successful such a forecaster did not have to have forecasted each company’s actual earnings changes. To exploit the concurrent earnings-change/ return-change effect a forecaster faced a much easier task. Such a forecaster merely would have had to build a portfolio of the approximately 150 stocks that would—in terms of relative earnings changes—fall into the best relative-earnings-change category one year later.
It is important to note that the concurrent earnings-change/ return-change effect is an ex post phenomenon. In here, Ex post means after the fact. As post meridiem means afternoon, the term ex post is used to refer to investment information that is known only after we invest. That is, when we look back after the end of each year, the portfolios that had the worst and best relative earnings changes over the course of the past year also provided the worst and best relative investment returns. The actual earnings changes used to form these portfolios were not known until after the fact. You cannot profit directly from the concurrent earnings-change/ return-change effect.