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)
October 18, 2015
Management Science, Forthcoming
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 methodologies. We find that recommendation changes motivated by earnings estimate revisions have a greater initial price reaction than the same recommendation changes without earnings estimate revisions: about 1.3% (-2.8%) greater for upgrades (downgrades). Nevertheless, the post-recommendation drift is also greater, suggesting that investors underreact to earnings-based recommendation changes. 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. Evidence from variation in firms' information environment and analysts' regulatory environment suggests that recommendation changes with earnings estimate revisions are less affected by analysts' cognitive and incentive biases.
Number of Pages in PDF File: 48
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: October 19, 2015
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