Returns to contrarian investment strategies: Tests of naive expectations hypotheses

This paper examines the ability of naive investor expectations models to explain the higher returns to contrarian investment strategies. Contrary to Lakonishok, Shleifer, and Vishny (1994), we find no systematic evidence that stock prices reflect naive extrapolation of past trends in earnings and sales growth. Building on Bauman and Dowen (1988) and La Porta (1995), however, we find that stock prices appear to naively reflect analysts' biased forecasts of future earnings growth. Further, we find that naive reliance on analysts' forecasts of future earnings growth can explain over half of the higher returns to contrarian investment strategies.