Earnings Season: Watching for Red Flags

 

As Corporate America enters the thick of the earnings season, beware of the red flags. Two Notre Dame professors, building on a Barron's story, have come up with statistical evidence that certain phrases in financial filings often signal trouble ahead.

We pointed to 13 danger phrases—dirty words, we called them—in a story two years ago ("Watch Their Language," Aug. 31, 2009). The piece caught the attention of Notre Dame professors Tim Loughran and Bill McDonald, who then performed an analysis of the phrases.

In a recently published study of more than 50,000 10-K filings dating from 1994 to 2008, the pair found that many of the phrases Barron's identified showed a statistically significant connection to future stock prices, volatility and analysts' profit estimates.

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