Analysts' Use of Earnings Forecasts in Predicting Stock Returns: Forecast Horizon Effects

17 Pages Posted: 14 Apr 2008

See all articles by Sati P. Bandyopadhyay

Sati P. Bandyopadhyay

University of Waterloo

Lawrence D. Brown

Temple University - Department of Accounting

Gordon D. Richardson

University of Toronto - Rotman School of Management

Abstract

Little attention has been paid to a principal decision context in which analysts' earnings forecasts are prepared, namely, as an input to their recommendations. We use two data sets, Value Line, USA, and Research Evaluation Service, Canada, and examine the importance of analysts' earnings forecasts for their stock price forecasts via three hypotheses: (1) analysts' earnings forecasts are important for their stock price forecasts; (2) analysts' long-term earnings forecasts are more important than their short-term earnings forecasts for their predictions of stock prices over a particular stock price forecast horizon; (3) the importance of analysts' earnings forecasts for their stock price forecasts rises as the joint earnings and stock price forecast horizon increases. We show that: (1) when the earnings forecast horizon is the next fiscal year, forecasted earnings explain only 30% of the variation in forecasted price; (2) the importance of forecasted earnings for forecasted price rises as the earnings forecast horizon increases; (3) in the long run, (i.e. three to five years hence), forecasted earnings explain about 60% of the variation in forecasted price. Decision usefulness is an ex ante concept, but tests regarding the usefulness of earnings for stock price generally have used actual (not expectational) data. Our evidence suggests that earnings expectations are decision useful, where the decision context is sell-side analysts' stock price forecasts. Our results are potentially important to users of sell-side analyst research reports. When a stock recommendation is accompanied only by short-run earnings forecasts, investors need to closely examine estimates of non-earnings variables to assess the quality of stock recommendations. In contrast, when stock recommendations are accompanied by both short-run and long-run earnings forecasts, investors need to examine estimates of non-earnings information variables less closely.

Keywords: Analysts, Earnings forecasts, Stock price forcasts, Value line (USA), Research evaluation service (Canada)

Suggested Citation

Bandyopadhyay, Sati P. and Brown, Lawrence D. and Richardson, Gordon D., Analysts' Use of Earnings Forecasts in Predicting Stock Returns: Forecast Horizon Effects. International Journal of Forecasting, Vol. 11, No. 3, 1995. Available at SSRN: https://ssrn.com/abstract=1118988

Sati P. Bandyopadhyay (Contact Author)

University of Waterloo ( email )

School of Accountancy
Waterloo, Ontario N2L 3G1
Canada
519-888-4567, ext. 2533 (Phone)
519-888-7562 (Fax)

Lawrence D. Brown

Temple University - Department of Accounting ( email )

Philadelphia, PA 19122
United States

Gordon D. Richardson

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
416-946-8601 (Phone)
416-971-3048 (Fax)

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