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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