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Can Investors Profit from the Prophets? Consensus Analyst Recommendations and Stock Returns

47 Pages Posted: 4 Nov 1998  

Brad M. Barber

University of California, Davis

Reuven Lehavy

University of Michigan, Stephen M. Ross School of Business

Maureen F. McNichols

Stanford University

Brett Trueman

University of California, Los Angeles (UCLA) - Anderson School of Management

Date Written: August 1998

Abstract

In this paper we document that an investment strategy based on the consensus (average) analyst recommendations of security analysts earns positive returns. For the period 1986-1996, a portfolio of stocks most highly recommended by analysts earned an annualized geometric mean return of 18.8 percent, while a portfolio of stocks least favorably recommended earned only 5.78 percent. (In comparison, an investment in a value-weighted market index earned an annualized geometric mean return of 14.5 percent.) Alternatively stated, purchasing stocks most highly recommended yielded a return of 102 basis points per month. The magnitude of this return is surprisingly large, and is far greater than the size effect (negative 16 basis points) and book-to-market effect (17 basis points) for the same period. Even after controlling for these two effects, as well as for price momentum, we show that the strategy of purchasing stocks most highly recommended and selling short those least favorably recommended yielded a return of 75 basis points per month. These results are robust to partitions by time period and overall market direction, and are most pronounced for small and medium-sized firms. The abnormal returns also persist when we allow a lapse of up to 15 days before acting on the investment recommendations. There is no extant theory of asset pricing that explains these results.

JEL Classification: G12, G14, G29

Suggested Citation

Barber, Brad M. and Lehavy, Reuven and McNichols, Maureen F. and Trueman, Brett, Can Investors Profit from the Prophets? Consensus Analyst Recommendations and Stock Returns (August 1998). Available at SSRN: https://ssrn.com/abstract=137400 or http://dx.doi.org/10.2139/ssrn.137400

Brad M. Barber (Contact Author)

University of California, Davis ( email )

Graduate School of Management
One Shields Avenue
Davis, CA 95616
United States
530-752-0512 (Phone)
530-752-2924 (Fax)

Reuven Lehavy

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI 48109
United States
734-763-1508 (Phone)
734-936-0282 (Fax)

Maureen F. McNichols

Stanford University ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
650-723-0833 (Phone)
650-725-7979 (Fax)

Brett Trueman

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States
310-825-4720 (Phone)
310-267-2193 (Fax)

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