Dow Schofield Watts llp

PRofit warnings

A profit warning is a description that analysts and journalists give to an unexpected corporate announcement that earnings for a specified future period will fall short of current expectations.

Warnings fall into two classes: those that include new earnings forecast (quantitative) and those that offer only the guidance that earnings will be below current expectations (qualitative). Both types of warning produce significant negative returns in the first three months following the announcement. 

The returns are significantly more negative following qualitative warnings and are significantly more negative for smaller companies. 

Approximately 90% of profit warnings precede the earnings announcement, to which they refer, by less than three months. Profit warnings are also a pure information event, and not a decision that has direct material consequences for the firm. 

Share prices drop on average by approximately 20% in the announcement window for a profit warning. It is a much larger fall than the average response to a large negative surprise in the scheduled earnings announcement. 

Share prices also continue to fall. Shares purchased two days after a profit warning, and held for the next three months also fall: 9.6% with a qualitative warning, over the next three months, and 2% following a quantitative warning. 

Companies that issue profit warnings broadly have a 50% likelihood of issuing a second profit warning, and those issuing a second warning have a 50% likelihood of issuing a third warning.  

Ernst & Young have tracked profit warnings from 1999 to 2005  

The analysis of those profit warnings is summarised in the tables below.