This earnings season some of Britain’s biggest blue chips have had their share prices hammered after undershooting profit expectations. Rolls-Royce, Pearson and BG Group have all felt the the market’s wrath for issuing disappointing financial results. But while missed targets can cause sudden price collapses, companies that actually beat earnings forecasts often experience something a bit different. In fact, share prices sometimes take a remarkably long time to adjust to profit surprises, and it’s then that investors can take advantage.

Come results day, City analysts and investors judge companies against the earnings per share (EPS) forecasts that have been laid down for them. A miss often ends in tears but a positive earnings surprise will naturally have the Champagne flutes clinking.

It’s reasonable to think that buying shares in one of these forecast-busting gems requires the quick-witted instinct of a ruthless trader, but that isn’t entirely true. While shares in over-achieving companies do often rise on results news, the price can then spend weeks or even months drifting higher.

Professionals think part of the reason for this drift is that markets are nowhere near as efficient as you might expect. The gradual incline is caused when investors are slow to digest the implications of a surprise and have to grapple with the idea of buying that share at a new high price. Meanwhile analysts, whose forecasts were proved wrong by the surprise, have to update all their financial modelling. They may even change their ‘buy’, ‘hold’ or ‘sell’ recommendation to fund managers. All this can take time.

For these reasons, positive surprises have earned themselves a name for contributing to something known as price momentum. Traditionally, it was thought that the stock market devoured any snippet of information and instantly priced shares accordingly. But decades of research have found flaws in that theory. Academics and fund managers now give huge credence to the idea that shares that have recently risen in price are more likely to keep rising - and hence offer better returns - than most other shares.

100 years of momentum

In 2008 Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School set out to test whether momentum was always at work in the market. They found that while it does periodically suffer vicious reversals of fortune, momentum has been consistently profitable for over a century. As a result, investors ought to be acutely aware…

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