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Do Earnings Estimates Add Value to Sell-Side Analysts' Investment Recommendations?

Management Science, Forthcoming

48 Pages Posted: 26 Sep 2009 Last revised: 28 Jul 2016

Ambrus Kecskes

York University - Schulich School of Business

Roni Michaely

Johnson@Cornell Tech, Cornell University

Kent L. Womack

University of Toronto - Rotman School of Management (Deceased)

Date Written: October 18, 2015

Abstract

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.

Keywords: Equity research analysts; Investment recommendations; Earnings estimates; Information; Valuation; Asset pricing; Trading strategy

JEL Classification: G14, G24

Suggested Citation

Kecskes, Ambrus and Michaely, Roni and Womack, Kent L., Do Earnings Estimates Add Value to Sell-Side Analysts' Investment Recommendations? (October 18, 2015). Management Science, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1478451 or http://dx.doi.org/10.2139/ssrn.1478451

Ambrus Kecskes

York University - Schulich School of Business ( email )

4700 Keele Street
Toronto, Ontario M3J 1P3
Canada

Roni Michaely (Contact Author)

Johnson@Cornell Tech, Cornell University ( email )

111 8th Avenue #302
New York, NY 10011
United States

Kent L. Womack

University of Toronto - Rotman School of Management (Deceased)

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