The Good, The Bad, and The Lucky: Projected Earnings Accuracy and Profitability of Stock Recommendations
51 Pages Posted: 18 Mar 2011 Last revised: 13 Aug 2012
Date Written: August 13, 2012
Abstract
Analysts who provide more accurate earnings forecasts also issue more profitable recommendations. We demonstrate how investors can profit from this contemporaneous link by differentiating between “able” and “lucky” analysts. In line with previous studies, we find that past track records alone are not sufficient to identify profitable recommendations. Only skilled analysts working in a superior environment provide consistently profitable recommendations. The overall profitability of their recommendations is not driven by a post-announcement drift effect. We find that an implementable, i.e., look-ahead bias free, trading strategy based on the projected – rather than past – earnings accuracy yields substantial excess returns.
The main difference of our approach is that we combine analysts’ past earnings accuracy with a broad range of analyst characteristics to assess their ability. This approach enables us to identify ex ante analysts who provide superior recommendations. We show that it is essential to take into account the ability of analysts in addition to their past performance, i.e., to look beyond their track record.
Our results suggest that identifying the more skilled processors of information is crucial, while following analysts based on only their past performance alone is not profitable. Moreover, our approach provides a promising avenue for research that uses analysts’ outputs to capture the expectations of market participants or evaluates incentives and compensation of financial intermediaries.
Keywords: analysts, portfolio management, profitability of recommendations
JEL Classification: G14, G17, G24
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Can Investors Profit from the Prophets? Consensus Analyst Recommendations and Stock Returns
By Brad M. Barber, Reuven Lehavy, ...
-
Security Analysts' Career Concerns and Herding of Earnings Forecasts
By Jeffrey D. Kubik, Amit Solomon, ...
-
By Patricia Dechow, Amy P. Hutton, ...
-
Analyzing the Analysts: When Do Recommendations Add Value?
By Narasimhan Jegadeesh, Joonghyuk Kim, ...
-
An Empirical Analysis of Analysts' Target Prices: Short Term Informativeness and Long Term Dynamics
By Alon Brav and Reuven Lehavy
-
How Do Analysts Use Their Earnings Forecasts in Generating Stock Recommendations?