Post Earnings Announcement Drift Trading System & Strategy (PEAD) is another one of the most significant stock market anomalies to have been discovered. The idea is that when a stock releases earnings that are a big surprise to the market, the stock tends to drift in the direction of that surprise for up to 60 days after the announcement.
Since the efficient market hypothesis postulates that new information is almost instantaneously incorporated into a stock price, the observance of Post Earnings Announcement Drift Trading Strategy suggests that the market is not perfectly efficient.
According to a paper by Brandt and Kishore, PEAD is capable of abnormal returns (in excess of the market) of about 12.5% annually.
The most popular explanation for Post Earnings Announcement Drift Trading System & Strategy is that investors typically under-react to earnings surprises and it takes time for the new information to filter through and get priced into the market.
The following chart from Mr. Damodaran shows the effect very clearly:
Trading System & Strategy:
The way to trade PEAD is to buy stocks with the strongest positive earnings surprises and short stocks with the strongest negative earnings surprises. Trades can be held from 1 to 60 days after the announcement to capture the drift.