Profitability of Portfolio Strategies Based on Analyst Consensus EPS Forecasts

Abstract

We introduce a new measure of stock misevaluation, 𝑄, which is consistent with the Gordon growth model for firm valuation. In our empirical application, we use 𝑄 to relate analyst forecasts to stock returns and measure the profitability of investment strategies that rely on information in analyst earnings-per-share forecasts and stock prices. Over a time period of more than 40 years, we analyze portfolio strategies within a highly liquid US stock universe. Over the whole period, self-financing trading strategies yield annualized Fama and French five-factor alphas of up %-|-|-|. These strategies clearly outperform existing pure earnings-forecast momentum strategies and remain profitable after transaction costs. We show that analysts provide valuable information until the end of the 20th century, while they lose some of their informational advantages in the 21st century.

Keywords: asset pricing, analyst research, earnings per share consensus forecasts, earnings forecast momentum, market efficiency, sell-side analysts

JEL Classification: G10, G11, G12, G14, G17