ANALYSTS DOWNGRADE CBA EARNINGS FORECAST SUMMARY OF ARTICLE As earnings forecasts for Commonwealth were downgraded by analysts due to the slowly growing revenue and rising bad debts, shares in Commonwealth Bank were under pressure. The share price of Commonwealth suffered the largest loss and dropped by $1. 27, or 3. 5 percent, to $35. 47. In addition, the stock price of Big Four banks reacted in the same way. National Australia Bank was down 54c to $21. 18. The share price for Westpac decreased by 40c to $20. 20 and ANZ Bank closed down 34c to $15. 37.
ACCOUNTING THEORY ISSUE: The accounting issue encapsulated in this article is the responsiveness of the share price to earnings forecasts, one form of publicly available information. More importantly, such impact was not limited to the company to which the forecast was directed, specifically Commonwealth, but diffuses onto the other banks in the industry in general as well. ACCOUNTING THEORY APPLICATION: As per EFFICIENT MARKET HYPOTHESIS, the Australian equity market is generally consistent with its semi-strong efficient form (Watts and Zimmerman, 1986; p. 9). All publicly available information, including all financial statements and other financial disclosures, will be rapidly and fully impounded into share price in an unbiased manner in the semi-strong efficient equity. In particular, an increase in share price indicates a good news and vice versa. If there is no price movement after the release of information, it is evidenced that the information fails to provide something new or all the information has already been anticipated. Simply put, it does not have information content.
Ball and Brown (1968), for instance, specifically 3 concluded that unexpected earnings announcement has an impact on share prices. Investors generally respond to new information that significantly revises their valuation as to the potential future cash flows attributable to the company, and this is reflected in the share price. According to the news article, the share price of Commonwealth went down by 3. 5 percent due to the analysts downgrading its earnings forecasts. In relation to this, two points should be noted.
Firstly, the information contained in the earnings forecast had not been anticipated by the public before its release. This unexpected information, causing the decrease in Commonwealth share price, was generated by differentiation between shrinking expected earnings and acceptable March-quarter cash profit, as well as the relatively low bad debt expenses of Commonwealth. Secondly, the earnings forecasts, considered to be a kind of financial disclosure available to the public, are likely to have effective impact on share price (Imhoff and Lobo, 1984; Penman, 1980).
Sound earnings forecasting deems to stimulate the increase of share price, while unfavorable forecasting contributes to the decrease of share price. As analysts downgraded earnings forecasts, investors relying on this information became reluctant to invest in Commonwealth yielding a drop in the stock price. Additionally, the Big Four banks in Australian all suffered a loss in stock price. Commonwealth’s share price decreased most significantly by $1. 27 to $35. 47. The share prices for National Australia Bank, Westpac and ANZ went down by $ 54c, 40c and 34c respectively.
This phenomenon is known as the information transfer (Forster, 1981) in which, provided the equity market is efficient, the earnings forecast for a particular organization tends to cause the positively correlated movement of share price for other organizations in the same industry. In the article in focus, the adverse earnings forecast for Commonwealth resulted in the decrease in its share price. In addition to that, such impact was magnified into the banking sector in general, manifested by the corresponding decrease in the share prices of other banks as well.