Do Earnings Estimates Add Value to Sell-Side Analysts' Investment Recommendations?
York University - Schulich School of Business
Cornell University - Samuel Curtis Johnson Graduate School of Management; Interdisciplinary Center (IDC)
Kent L. Womack
University of Toronto - Rotman School of Management (deceased)
April 18, 2015
Sell-side analysts change their stock recommendations when their valuations differ from the market's. These valuation differences can arise from either differences in earnings estimates or the non-earnings components of valuation models. Indeed, we find that recommendation changes motivated by earnings estimate revisions are more valuable to investors: about 1.3% (-2.8%) more for upgrades (downgrades). Evidence from variation in analysts' regulatory and firms' information environments suggests that recommendation changes with earnings estimate revisions are less subject to analysts' cognitive and incentive biases. Implemented as a trading strategy, earnings-based recommendation changes earn risk-adjusted returns of 3% per month, considerably more than non-earnings-based recommendation changes.
Number of Pages in PDF File: 37
Keywords: Equity research analysts; Investment recommendations; Earnings estimates; Information; Valuation; Asset pricing; Trading strategy
JEL Classification: G14, G24
Date posted: September 26, 2009 ; Last revised: April 19, 2015
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