It's the Earnings, Stupid! Analysts' Implicit Valuation Models and Their Recommendation Accuracy
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
July 31, 2013
Tuck School of Business Working Paper No. 2009-67
Johnson School Research Paper Series No. #40-09
A sell-side analyst changes his stock recommendation when his valuation of the firm differs from the market's current valuation. Such differences in valuation arise from different estimates of the stock’s earnings, and/or its discount rate relative to those of the market-setting consensus. Our main finding is that recommendation changes that are based on changes in earnings forecasts are more accurate and valuable to investors, possibly because they are less subject to analysts' cognitive and incentive biases. A simple trading strategy based on earnings-based-recommendation-changes earns average risk-adjusted returns of over 3% per month in the period 1994-2010.
Number of Pages in PDF File: 58
Keywords: analysts, brokers, recommendations, earnings, growth rates, discount rates, information, market efficiency
JEL Classification: G14, G24
Date posted: September 26, 2009 ; Last revised: September 3, 2013
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