The Predictability of Analyst Forecast Revisions
42 Pages Posted: 26 Jun 2017
Date Written: June 24, 2017
The most prevalent forecasts of firms’ long-term earnings issued by analysts are two-year-ahead earnings per share (EPS) estimates. When introduced by analysts, two-year-ahead EPS estimates set market expectations for firms’ future earnings. Subsequent revisions to these estimates are highly correlated with contemporaneous changes in stock prices. We examine whether such revisions are sufficiently predictable to enable investors to earn abnormal returns on hedged portfolios. We find that analyst forecast revisions are predictable and document an implementable strategy for investors. Consistent with investors’ fixation on unscaled EPS, the strategy earns positive abnormal returns using unscaled EPS revisions but not when revisions are scaled by the level of the EPS estimate or the stock price. Abnormal returns are found for firms with low analyst coverage, consistent with a greater initial mispricing from analyst optimism for firms with poorer information environments.
Keywords: analyst revisions, analyst forecasts, return predictability, stock returns
JEL Classification: M41
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