Financial Accounting: In an Economic Context

ANNUAL REPORT INFORMATION AND PREDICTING STOCK PRICES

It is well known that stock prices react to the disclosure of accounting information. Indeed, USA Today reported that “profits of public companies have the greatest and most immediate effect on the company's stock price,” and in a number of accounting and finance research studies, stock prices of companies traded on the U.S. stock markets have been shown to react almost instantaneously to the disclosure of accounting information. It is important to understand, at the same time, that published annual reports are not available to the public until several months after the balance sheet date, and important numbers, such as net income, are announced quarterly and are available to the public almost as soon as they are determined. Thus, it is difficult, if not impossible, for investors to use the information contained in an annual report to identify undervalued stocks traded on the public securities markets. Such information is not timely enough because the market price has already reacted to important accounting numbers that were released at an earlier date.

While annual report information in and of itself may not be particularly helpful in identifying undervalued publicly traded securities, this certainly does not mean that it is useless. There is evidence, for example, that annual report information, if analyzed in a superior fashion, can lead to better-than-average returns in the stock market. Such analysis may also help an investor ...